Question

2. (NOTE: You do not need a cash flow diagram for this problem.) Proctor and Gamble has a palletizer at the end of a packaging line that cost $72,500. Shipping and site preparation cost $800 and installation cost $400. At the end of the 3rd year of service, the palletizer was traded in for a new palletizer with a purchase price of $79,999, shipping and site preparation cost $1,000 and installation cost $400. The trade-in allowance was $27,000 for purchasing the new machine. This equipment is a 7-year MACRS class.

a) (30 pts) What is the cost basis of the new palletizer for computing the amount of depreciation for income tax purposes?

b) (12 pts) If instead of trading in the old palletizer, Proctor and Gamble sold the palletizer on the open market for $27,000, then:

i) What is the cost basis of the new palletizer?

ii) For the sold old palletizer, will Proctor and Gamble need to pay a gains tax of get a tax benefit and calculate the value (assume 21% tax rate).

Please answer in format below. Please show all work:

1. Cash flow diagram of your problem (unless stated otherwise)

2. Specify the model/equation used [e.g. P=F(1+i)-N ]

3. Specify the values of each parameter [e.g. i=0.05 or 5% ]

4. Show your work for how you calculate your numerical results.

5. Report dollar value with cents (e.g. $253.12),

6. Answer the question of the problem with a complete sentence that includes your numerical justification.

Answer 1

a. Depreciation schedule and value of old machine :

Hence the value of old machine at the end of Year 3 in the books of P&G was $32229.01.

Now the total cost of new machine including the shipping & installation is (79999 + 1000 + 400) = $81399. The trade in is $27000, hence P&G shall pay in cash only (81399 - 27000) = $54399. In addition the value of the old asset in books of P&G was $32229.01, which shall be added to the cash paid for new machine to arrive at the depreciable base for new machine : (54399+32229.01) = $86628.01

(ii) If the old machine was sold in the open market, then the depreciation base for the new machine would be its total acquisition cost of $81399. But the company would book a loss of (32229.01 - 27000) = $5229.01 on sale of old machine . At 21% tax rate, it will mean tax benefit of (5229.01 * 21%) = $1098.09.