Problem 2 Use the following data to work. ... [FREE SOLUTION]

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Chapter 24: Problem 2

Use the following data to work. Michael is an Internet service provider. On December 31,2014 , he bought an existing business with servers and a building worth $\$ 400,000 .$ During $2015,$ his business grew and he bought new servers for $\$ 500,000 .$ The market value of some of his older servers fell by $\$ 100,000$. What is the value of Michael's capital at the end of $2015 ?$

Short Answer

Expert verified

$\$800,000$

Step by step solution

Initial Capital Value

Determine the initial capital value Michael started with: the servers and building worth $ \$400,000 $.

Additional Purchase Value

Add the value of new servers purchased during 2015 which is $ \$500,000 $.

Depreciation of Old Servers

Subtract the depreciation in the value of the older servers. This depreciation is $ \$100,000 $.

Calculate Total Capital Value

Calculate the total value of Michael鈥檚 capital at the end of 2015 using the formula: \[ \text{Total Capital} = \text{Initial Capital} + \text{Additional Purchases} - \text{Depreciation} \] Substituting the given values: \[ \text{Total Capital} = \$400,000 + \$500,000 - \$100,000 = \$800,000 \]

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Initial Capital

Michael started with a specific amount of capital when he bought the existing business. This includes assets such as servers and a building, which were worth
$$\$400,000$on December 31, 2014. This initial capital is the foundation upon which Michael will build and grow his business. To put it simply, this is the starting point or the first investment Michael made.
The concept of initial capital is essential because it represents the initial resources available to run and expand the business. Without it, there would be no starting point for operations or growth opportunities.

Additional Purchases

As Michael鈥檚 business grew during 2015, he decided to invest further in his infrastructure. He bought new servers costing $\$500,000$. Additional purchases are important as they reflect the expansion and improvement in business capabilities.
These investments enhance the company鈥檚 ability to serve more clients and improve performance. It is crucial to keep track of these purchases because they add to the initial capital, making the business more valuable and robust.
Additional investments like these are often made based on projected growth and needs, contributing to the overall value of the business.

Depreciation

Over time, the value of assets such as servers can decline. For Michael, some of his older servers depreciated by $\$100,000$in 2015. Depreciation is a reduction in the value of an asset over time, often due to wear and tear or obsolescence.
It is important to account for depreciation because it affects the total value of the business's assets. Ignoring depreciation can give an inflated picture of a company's worth.
Depreciation is usually calculated annually and helps businesses in planning for replacements or upgrades, ensuring they maintain effective operational capacity.

Total Capital Value

By the end of 2015, Michael needs to calculate the total value of his business capital. The total capital value is determined by the formula:

\text{Total Capital} = \text{Initial Capital} + \text{Additional Purchases} - \text{Depreciation}

Substituting in the values:

\text{Total Capital = $\$400,000$ + $\$500,000$ - $\$100,000$ = $\$800,000$

This calculation is an essential part of understanding the overall financial health of the company. It factors in the expansion investments while recognizing the reduction in value from depreciation. By accurately calculating the total capital, Michael can make informed decisions about future investments and business strategies.

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