New Machine Will Cost 180,000 And Is Expected To Have An Eco

New Machine Will Cost 180000 And Is Expected To Have An Economic Life

New machine will cost 180,000 and is expected to have an economic life of 8 years but is expected to use the MACRS 5 year asset class depreciation schedule for tax purposes. It is expected to have a salvage value of 12% of the original equipment costs at the end of 8 years. The remaining operational years beyond the depreciation tax schedule will not have any depreciation expense but will continue to have operational impact.

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The investment in new equipment is a crucial decision for any organization aiming to enhance operational efficiency and financial performance. In this analysis, we evaluate the financial implications of acquiring a new machine that costs $180,000, with an expected economic life of 8 years, employing the Modified Accelerated Cost Recovery System (MACRS) 5-year asset class for depreciation, and considering its salvage value of 12% at the end of the asset's useful life.

Depreciation Under MACRS 5-Year Schedule

The MACRS depreciation schedule accelerates the depreciation expense in early years, providing significant tax benefits. For a 5-year property, the depreciation percentages for each year are predetermined by tax law (Internal Revenue Service, 2021). These percentages are: Year 1 – 20%, Year 2 – 32%, Year 3 – 19.2%, Year 4 – 11.52%, Year 5 – 11.52%, Year 6 – 5.76%, with the remaining depreciation captured in subsequent years, but since the asset's economic life is 8 years, depreciation stops after the 5-year MACRS schedule.

Salvage Value Calculation

At the end of 8 years, the machine is expected to have a salvage value of 12% of its original cost. This equates to:

Salvage Value = 0.12 × $180,000 = $21,600

It is important to note that depreciation will only be claimed for 5 years under MACRS. Afterward, the asset continues to impact operations without depreciation, implying that the book value may differ from the tax basis, and the salvage value will influence future cash flows when the asset is disposed.

Implications of Accelerated Depreciation

The MACRS schedule's accelerated depreciation allows the company to front-load tax deductions, reducing taxable income significantly during the initial years. This strategy enhances cash flow in early years, which can be reinvested or used to offset other expenses. However, since depreciation ceases after 5 years, the remaining operational value from years 6 to 8 does not provide further depreciation benefits, though operational impacts persist.

Operational Impact Beyond the Depreciation Schedule

Although the depreciation expense ceases, the machine's operational contributions continue. This residual value should be considered when evaluating total return on investment, especially when considering disposal or resale of the asset at the end of its useful life.

Financial Analysis Approach

A comprehensive financial analysis involves calculating the net present value (NPV) of the investment, considering initial costs, depreciation tax shields, operational cash flows, salvage value, and the tax implications of disposal. Using the corporate tax rate, market discount rate, and expected operational cash flows, an organization can determine the viability and profitability of the investment.

Additional Considerations

Other factors include maintenance costs during operational years, potential changes in salvage value estimates, and the impact of residual operational value. It is also prudent to assess the environmental and technological risks associated with the new machine, to ensure long-term sustainability.

Conclusion

Investing in a machine costing $180,000 with an 8-year operational horizon and utilizing MACRS 5-year depreciation offers tax advantages and improved operational capability. By carefully analyzing depreciation schedules, salvage value, and ongoing operational impacts, organizations can make informed decisions that optimize financial outcomes and operational efficiency.

References

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