Question

Consider the situation in which it has been proposed to replace an outmoded piece of equipment with a new machine. Suppose the old machine had not been fully depreciated and that it would be sold when the new machine was installed. What about the tax shelter from the future depreciation of the old machine? This should be considered:

A) Irrelevant
B) An incremental benefit
C) An incremental cost
D) Tax-related impact

Answer 1

The tax shelter from future depreciation of the old machine should be considered a Tax-related impact in the analysis of replacing equipment because it affects the present discounted value of the new investment by influencing future taxable income.

Step-by-step explanation:

The tax shelter from the future depreciation of the old machine should be considered a Tax-related impact. When a business is considering replacing an outmoded piece of equipment, the depreciation on the old machine can no longer be used to offset future income if the machine is sold, which influences the present discounted value of the new investment. This is because the depreciation would have provided a tax shelter by reducing taxable income, thereby lowering the tax burden for the business.

However, with the sale of the old machine, this tax advantage is lost. Therefore, it is an important factor in the cost-benefit analysis of the investment decision in new machinery. It is not merely an incremental cost or benefit but a specific financial impact relating to taxes, which affects the overall evaluation of the investment from a tax perspective.