Suppose the Diamond Jubilee pays combined state and federal taxes equal to 25% of profit. Since the casino is highly profitable, this means that any increase in casino revenues will be taxed at the rate of 25%. It also means that depreciation on the machines is deductible for tax purposes. Finally, it means that the casino can write off the loss if it sells the recently acquired video poker machines. That is, the loss on the recently acquired video poker machines produces a benefit to the Diamond Jubilee because it shields income from being taxed.

Required:

a. If taxes are ignored, does the $1,250,000 cost of the recently acquired video poker machines affect the decision to purchase the better video poker machines?

b. With taxes, how does the $1,250,000 cost of the recently acquired video poker machines affect the Diamond Jubilee's taxes if the old machines are retained? How does the $1,250,000 cost of the recently acquired machines affect the Diamond Jubilee's taxes if the old machines are sold and the new machines are purchased? In both cases, assume the Diamond Jubilee depreciates all of their gaming equipment using straight-line depreciation and zero assumed salvage value. Ignore the time value for money in your computations.

c. Considering tax effects, by how much will the Diamond Jubilee's profit increase or decrease over the next two years if it purchases the new video poker machines and sells the recently acquired video poker machines?

d. What do you conclude about the relevance of sunk costs?