A firm has an opportunity to invest in a new device that will replace two of the
firm’s older machines. The new device costs $570,000 and requires an additional outlay of $30,000 to cover installation and shipping. The new device will cause the firm to increase its net working capital by $20,000. Both the old machines can be sold—the first for $100,000 (book value equals $95,000) and the second for
$150,000 (book value equals $75,000). The original cost of the first machine was $200,000, and the original cost of the second machine was $140,000. The firm’s marginal tax bracket is 40 percent. Compute the net investment for this project
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To compute the net investment for this project, we need to consider the initial cost of the new device, any additional costs, the proceeds from selling the old machines, and changes in net working capital.
1. Initial cost of the new device: $570,000
2. Additional costs for installation and shipping: $30,000
3. Proceeds from selling the first machine: $100,000 (book value $95,000)
4. Proceeds from selling the second machine: $150,000 (book value $75,000)
5. Net working capital increase: $20,000
To calculate the net investment, we need to add up the costs and subtract the proceeds, taking into account the tax implications. Here's how to calculate it step by step:
Step 1: Calculate the total cost of the new device:
Total cost = Initial cost + Additional costs
Total cost = $570,000 + $30,000 = $600,000
Step 2: Calculate the proceeds from selling the old machines:
Proceeds = Selling price - Book value
Proceeds from the first machine = $100,000 - $95,000 = $5,000
Proceeds from the second machine = $150,000 - $75,000 = $75,000
Step 3: Calculate the tax savings from selling the old machines:
Tax savings = Proceeds * Tax rate
Tax savings from selling the first machine = $5,000 * 0.4 = $2,000
Tax savings from selling the second machine = $75,000 * 0.4 = $30,000
Step 4: Calculate the net investment:
Net investment = Total cost + Net working capital increase - Tax savings
Net investment = $600,000 + $20,000 - ($2,000 + $30,000) = $588,000
Therefore, the net investment for this project is $588,000.