Question

The Jones Company has just completed the third year of a​ 5-year diminishing value recovery period...

The Jones Company has just completed the third year of a​ 5-year diminishing value recovery period for a piece of equipment it originally purchased for $ 297 000. The depreciation rate is 40​%. a. What is the book value of the​ equipment? b. If Jones sells the equipment today for $ 80 000 and its tax rate is 30 %​, what is the​ after-tax cash flow from selling​ it? c. Just before it is about to sell the​ equipment, Jones receives a new order. It can take the new order if it keeps the old equipment. Is there a cost to taking the order and if​ so, what is​ it? Explain.​ (Assume the new order will consume the remainder of the​ machine's useful​ life.)

a. The book value of the equipment after the third year is ​$ nothing. ​(Round to the nearest​ dollar.) b. If Jones Company sells the equipment today for $ 80 000 and its tax rate is 30 %​, the total​ after-tax proceeds from the sale will be ​$ nothing. ​(Round to the nearest​ dollar.) c. Just before it is about to sell the​ equipment, Jones receives a new order. It can take the new order if it keeps the old equipment. Is there a cost to taking the order and if​ so, what is​ it? Explain. ​ (Select the best choice​ below.) A. ​Yes, the cost of taking the order is the extra depreciation on the machine. B. ​Yes, the cost of taking the order is the lost $ 64 152 in book value. C. ​Yes, the cost of taking the order is the lost​ after-tax cash flow of $ 75 246 from selling the machine. D. ​No, Jones already owns the​ machine, so there is no cost to using it for the order.

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Answer #1

a]

book value of company at end of third year = $297,000 * (1 - 40%)3 = $64,152

b]

book value = $64,152

sale price = $80,000

tax on sale of equipment = ($80,000 - $64,152) * 30% = $4,754

after-tax cash flow = $80,000 - $4,754 = $75,246

c]

The answer is D - there is no cost as the machine is already owned

A is incorrect as there is no extra depreciation. the depreciation would have been incurred irrespective of the new order

B is incorrect as book value is irrelevant

C is incorrect as the after-tax cash flow from sale of equipment will now be received at the end of fifth year (although the salvage value at the end of 5th year will be considerably lower, or even zero, the depreciation tax shield may offset this. Additional data is required)

The best answer is (D)

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