Question

Adam Smith is considering automating his pin factory with the purchase of a $475,000 new machine in replacement of old machine. Shipping and installation would cost $6,000. The old machine having a depreciated book value of $200,000 is sold with market value of $300,000. The pin factory requires an additional working capital of $80,000. The machine has a useful life of 4 years The firm's marginal tax rate is 40 percent. The incremental cash outflow at time period 0 is closest to

275000

300000

221000

375000

350000

Answer 1

The old machine having a depreciated book value of $200,000 is sold with market value of $300,000.

Hence, gain on sale, G = MV - BV = 300,000 - 200,000 = 100,000

Tax on gain, A = G x T = 100,000 x 40% = 40,000

Hence, the  incremental cash outflow at time period 0 = Cost of new machine +  Shipping and installation - Market value of old machine + Tax on gain on sale of old machine + Additional working capital = 475,000 + 6,000 - 300,000 + 40,000 + 80,000 = $ 301,000

Hence, the closest value is 300000

Hence, the correct answer is the second option showing 300000.