a. Prepare a response with supporting calculations (if appropriate) to the two tax related questions raised by Smith in conjunction with the possibility of trading in rather than selling the existing machine outright (if the new machine were purchased): (1) Would there be any tax advantage to trading in (rather than selling) the old asset? (2) What would the breakeven value of the trade in be? When responding to Smith’s second question, assume base-case data. For purposes of responding to this question, you can ignore the incremental investment in net working capital (if any) that would be required if the new asset is purchased.

b. Prepare a response, with appropriate authoritative support, to the two questions raised by Smith regarding the provisions of IRC §179, as it pertains to expensing of the cost of the replacement asset: Does XYZ have this option? What are the benefits of this option (if any)?

c. Prepare a response, with authoritative support, to Chang’s issue regarding the STARKER escrow: What is it and is it applicable to the present situation?

XYZ Company was formed in the United States seven years ago by Jim Smith, Marsha Chang, and Earl Watson, who together purchased a commercial machine shop that had been in business for more than 40 years but, at the time of the acquisition, was feeling pressure from a variety of new entrants into the markets in which the machine shop competed. Smith had a distinguished military career and felt he could use the skills he acquired in the military to help this business return to its previously highly profitable state. Smith currently serves as the president and CEO of the company. XYZ produces three primary product lines, all of which are made of brass and are water-related: flow controllers, valves, and pumps. Marsha Chang, a long-time friend of Smith and his family, and a practicing CPA (Certified Public Accountant) and CMA® (Certified Management Accountant), joined the company as its CFO shortly before the formation of XYZ. Earl Watson, a high school friend of Smith, had worked as the manufacturing supervisor at the company for the past 10 years and, at the request of Smith, decided to stay onboard after the formation of XYZ. Over the past several years, Watson had toyed with the idea of introducing more technologically up to-date equipment that, he thought, could help ameliorate the competitive position of the company. Recently, Chang instituted an activity-based costing (ABC) system and a “bare-bones” Enterprise Resource Planning (ERP) system that, among other things, helped the company assess customer profitability and price its products more competitively. A new marketing manager, Maria Sanchez, was hired last year to develop and implement an aggressive product-promotion plan.