Mr. Hobbes Bed & Breakfast is considering the replacement of some old equipment. The new equipment will cost $86,000 including delivery and installation. The old equipment to be replaced has a book value of $60,200 and can be sold pre-tax for $61,200. If the firm’s effective tax rate is 25%, compute the net investment.

$25,550

Explanation:

For computing the net investment first we have to find out the loss or gain on sale of old equipment which is shown below:

Sale value = $61,200

Less: Book value of old equipment = $60,200

Gain = $1000

Now

Tax on gain is

= $1,000 × 25%

= $250

So, the net gain is

= $1,000 - $250

= $750

Now the net investment is

= Cost of new equipment - sale value pre tax + net gain

= $86,000 - $61,200 + $750

= $25,550

Net Investment = $25,550

Explanation:

Given:

Sale value (old equipment) = $61,200

Book value of old equipment = $60,200

New equipment cost = $86,000

Effective tax rate = 25%

Computation

Gain on sale = $61,200 - $60,200

Gain on sale = $1,000

Amount of tax on gain = $1000 × 25%

Amount of tax on gain = $250

Net Gain = Gain on sale - Amount of tax on gain

Net Gain = $750

Net Investment = Cost of new equipment - (Sale value - Net Gain)

Net Investment = $86,200 - (61,200 - 750)

Net Investment = $25,550

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