The Tenang Corporation is using a machine that originally cost RM88,000.00. The machine is being depreciated by the straight-line method over 8 years and has 4 years of depreciation remaining. The machine has a book value of RM44,000.00 and a current market value of RM40,000.00. Jacqueline , the Chief Financial Officer of Tenang, is considering replacing this machine with a newer model costing RM75,000. The new machine will save RM5,000 in after-tax earnings each year for the next six years. The new machine will be depreciated using straight line method. Tenang Corporation is in the 28% tax bracket and has a 10 percent cost of capital. REQUIRED: Calculate the cash inflows from the sale of the old machine. Calculate the net cost of the new machine. Calculate the incremental depreciation on the new versus the old machine.
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
The Tenang Corporation is using a machine that originally cost RM88,000.00. The machine is being
Jacqueline , the Chief Financial Officer of Tenang, is considering replacing this machine with a newer model costing RM75,000. The new machine will save RM5,000 in after-tax earnings each year for the next six years. The new machine will be depreciated using straight line method. Tenang Corporation is in the 28% tax bracket and has a 10 percent cost of capital.
REQUIRED:
- Calculate the
cash inflows from the sale of the old machine. - Calculate the net cost of the new machine.
- Calculate the incremental depreciation on the new versus the old machine.
- Determine the
net present value of the new machine. Should they purchase the new machine?
- The NPV rule states that, “An investment should be accepted if the net present value [NPV] is positive and rejected if it is negative.” What does an NPV of zero mean? If you were a decision-maker faced with a project with a zero NPV (or very close to zero) what would you do? Why?
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