Use the following information to answer the following question(s).
A firm is trying to determine whether to replace an existing asset.The proposed asset has a purchase price of $50,000 and has installation costs of $3,000.The asset will be depreciated over its five year life using the straight-line method.The new asset is expected to increase sales by $17,000 and non-depreciation expenses by $2,000 annually over the life of the asset.Due to the increase in sales,the firm expects an increase in working capital during the asset's life of $1,500,and the firm expects to be able to sell the asset for $6,000 at the end of its life.The existing asset was originally purchased three years ago for $25,000,has a remaining life of five years,and is being depreciated using the straight-line method.The expected salvage value at the end of the asset's life (i.e. ,five years from now)is $5,000;however,the current sale price of the existing asset is $20,000,and its current book value is $15,625.The firm's marginal tax rate is 34 percent and its required rate of return is 12 percent.
-If the new machine is purchased,depreciation expense will increase or decrease by
A)increase $8,000.
B)increase $6,900.
C)increase $6,300.
D)decrease $5,000.

Question

Quizplus · Accepted Answer

The annual depreciation expense of the new asset is calculated as: 
($50,000 + $3,000 - $6,000)/5 = $9,400

The increase in sales revenue is $17,000 and the increase in non-depreciation expenses is $2,000 annually. Therefore, the incremental pre-tax cash flow each year is: 
$17,000 + $2,000 - $9,400 = $9,600

The increase in working capital is $1,500 annually, so the incremental after-tax cash flow each year is: 
$9,600 - ($1,500 x 0.34) = $8,760

Over the five-year life of the asset, the total incremental after-tax cash flow is: 
$8,760 x 5 = $43,800

The net investment in the new asset is $50,000 + $3,000 = $53,000. 
Therefore, the net present value of the new asset is: 
NPV = -$53,000 + $43,800/(1.12)^1 + $9,400/(1.12)^2 + $9,400/(1.12)^3 + $9,400/(1.12)^4 + ($9,400 + $6,000)/(1.12)^5 
NPV = -$17,606

Since the NPV is negative, the firm should not replace the existing asset with the new asset.

The annual depreciation expense of the existing asset is: 
($25,000 - $5,000)/5 = $4,000

Therefore, if the new machine is purchased, depreciation expense will increase by:
$9,400 - $4,000 = $5,400

However, since the firm should not replace the existing asset with the new asset, the answer is not D. The correct answer is B, which is the increase in annual depreciation expense of the new asset.

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