Chapter 12, Problem 33P

a.

Summary Introduction

To calculate: The book value of the old equipment.

Introduction:

Book value:

It refers to the total worth of the company if it liquidates all its assets and pays off all the liabilities. It can also refer to the price of an asset as recorded in the balance sheet.

MACRS depreciation method:

Modified Accelerated Cost Recovery System (MACRS) is a tool of depreciation used in the U.S. for tax purposes. This system places all the assets into categories with predetermined depreciation periods.

Answer to Problem 33P

The calculation of the old equipment’s book value is shown below:

Hence, the book value of the old equipment is $27,480

Explanation of Solution

The formulae used for calculation of old equipment’s book value are shown below:

b.

Summary Introduction

To calculate: The tax loss that will be incurred on the sale of the old equipment.

Introduction:

Tax loss:

It is that loss incurred when the total deduction that can be claimed in a financial year exceeds the total assessable income of that year.

Answer to Problem 33P

The tax loss that will be incurred on the sale of the old equipment is $3,040.

Explanation of Solution

The calculation of the tax loss on the sale of the old equipment is shown below.

$\begin{array}{c}\text{Tax Loss on Sale}=\text{Book Value of Old Equipment}-\text{Selling Price of Old Equipment}\\ =\$27,840-\$24,800\\ =\$3,040\end{array}$

c.

Summary Introduction

To calculate: The tax benefit from the sale of the old equipment.

Introduction:

Tax benefit:

It refers to the allowable deductions on the assessable income of the taxpayer with the intent of reducing their tax liability and burden.

Answer to Problem 33P

The tax benefit from the sale of the old equipment is $1,064.

Explanation of Solution

The calculation of the tax benefit from the sale of the old equipment is shown below.

$\begin{array}{c}\text{Tax Benefit}=\text{Tax Loss on Sale}\times \text{Tax Rate}\\ =\$3,040\times 35\%\\ =\$1,064\end{array}$

d.

Summary Introduction

To calculate: The cash inflow from the old equipment’s sale.

Introduction:

Cash inflow:

It is the money received by the firm as the result of its operating, investing and financing activities and is recorded in the cash flow statement.

Answer to Problem 33P

The cash inflow from the old equipment’s sale is $25,864.

Explanation of Solution

The calculation of the cash inflow from the old equipment’s sale is shown below.

$\begin{array}{c}{\text{Cash Inflow}}_{\left(\text{Old Equipment}\right)}=\text{Selling Price of Old Equipment}+\text{Tax Benefit}\\ =\$24,800+\$1,064\\ =\$25,864\end{array}$

e.

Summary Introduction

To calculate: The new equipment’s net cost.

Introduction:

Net cost:

The cost computed by deducting all the benefits related to an object from its gross cost is termed as the net cost.

Answer to Problem 33P

The net cost of the new equipment is $122,136.

Explanation of Solution

The calculation of the net cost of the new equipment is shown below.

$\begin{array}{c}\text{Net Cost of New Equipment}=\text{Cost of New Equipment}-{\text{Cash Inflow}}_{\left(\text{Old Equipment}\right)}\\ =\$148,000-\text{\$25,864}\\ =\$122,136\end{array}$

f.

Summary Introduction

To prepare: The depreciation schedule of new equipment.

Introduction:

Depreciation schedule:

A table that shows the amount of depreciation of a particular asset over the years of its usage is termed as depreciation schedule.

MACRS depreciation method:

Modified Accelerated Cost Recovery System (MACRS) is a tool of depreciation used in the U.S. for tax purposes. This system places all the assets into categories with predetermined depreciation periods.

Answer to Problem 33P

The depreciation schedule of new equipment is shown below.

Explanation of Solution

The formulae used for the preparation of the depreciation schedule of the new equipment are shown below.

g.

Summary Introduction

To prepare: The depreciation schedule for the old equipment of its remaining years.

Introduction:

Depreciation schedule:

A table that shows the amount of depreciation of a particular asset over the years of its usage is termed as depreciation schedule.

MACRS depreciation method:

Modified Accelerated Cost Recovery System (MACRS) is a tool of depreciation used in the U.S. for tax purposes. This system places all the assets into categories with predetermined depreciation periods.

Answer to Problem 33P

The depreciation schedule for the old equipment of its remaining years is shown below:

Explanation of Solution

The formulae used for the preparation of the depreciation schedule of the residual years of the old equipment are shown below.

h.

Summary Introduction

To calculate: The incremental depreciation with respect to the old and the new equipment and the depreciation tax shield benefit.

Introduction:

MACRS depreciation method:

Modified Accelerated Cost Recovery System (MACRS) is a tool of depreciation used in the U.S. for tax purposes. This system places all the assets into categories with predetermined depreciation periods.

Depreciation tax shield:

It is a particular kind of a tax shield provided to an individual or corporation in which depreciation as an expense is deducted from taxable income.

Answer to Problem 33P

The calculation of the incremental depreciation of the old and new equipment and the tax shield benefit are shown below.

Explanation of Solution

The formulae used for the calculation of the incremental depreciation of the old and new equipment and the tax shield benefit are shown below.

i.

Summary Introduction

To calculate: The after-tax benefits of cost savings.

Introduction:

After-tax benefits:

After-tax benefits are deductions that individuals are eligible for after the calculation of income tax calculated.

Answer to Problem 33P

The calculation of the after-tax benefits of cost savings is shown below.

Explanation of Solution

The formulae used for the calculation of the after-tax benefits of cost savings are shown below.

j.

Summary Introduction

To calculate: The PV of the total cash inflow (sum of depreciation tax shield and after tax benefits).

Introduction:

Present value (PV):

The current value of an investment or asset is termed as its present value. It is calculated by discounting the future value of the investment or asset.

Cash inflow:

It is the money received by the firm as the result of its operating, investing and financing activities and is recorded in the cash flow statement.

Answer to Problem 33P

The calculation of the PV of the total cash inflow is shown below.

Explanation of Solution

The formulae used for the calculation of the present value of the total cash inflow are shown below.

k.

Summary Introduction

To determine: Whether the replacement should be done or not.

Introduction:

Net present value (NPV):

It is the difference between the PV (present value) of cash inflows and that of cash outflows. It is used in capital budgeting and planning investments to assess the benefits and losses of a project or investment.

Answer to Problem 33P

The replacement should be done because the NPV of the project is $46,211, and a positive NPV indicates that the replacement is beneficial for the corporation.

Explanation of Solution

The calculation of the NPV of the replacement is as follows.

$\begin{array}{c}\text{NPV}=\text{Total Present Value of Cash Inflow}-\text{Net Cost of New Equipment}\\ =\$168,347-\$122,136\\ =\$46,211\end{array}$