1. The book value is 5000 - 500*5 = \$2500

2. The resale value of the old machine is the investment value of the defender. That is \$4000.

3. There is a capital gain of \$1500 if the old machine is sold. The tax on the gain is \$300. The amount realized if the defender is sold is: 4000 - 300 = \$3700. This is the investment in the defender.

4. In this case there would be a capital loss of \$2500. The capital gains tax would savings would result in a tax savings of \$500. This is the investment that should be attached to the defender.

5. The economic life of the machine is one year.

6. The investment is the net value we would realize from selling the old asset after taxes and paying the fixup costs.

Gain on sale of the old asset = (2000 - 4000) = -2000 (a loss)

Cost of fixup before disposal is tax deductible (-1000)

Tax = (2000 - 1000 - 4000)*0.2

= (- 3000)*0.2 = - 600

This is the tax effect if we sold the old asset.

Investment = Market value - tax - disposal cost.

Investment = 2000 - (- 600) - 1000 = 1600.

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