Question

1. Heald and Swenson Inc. purchased a drill press for $850,000 one year and nine months ago. The asset has a six-year life and has been depreciated according to the following accelerated schedule.

Year Percent of Cost

1 ................55%

2 ................20%

3 ................10%

4 ..................5%

5 ..................5%

6 ..................5%

The press was just sold for $475,000. The firm’s marginal tax rate is 35%. Calculate Heald and Swenson’s taxable profit and cash flow on the sale. Assume depreciation is spread evenly within each year.

2. Use the following tax brackets for taxable income:

Bracket: Tax Rate

0–$10,000 15%

$10,000–$50,000 25%

$50,000–$250,000 30%

Over $250,000 35%

Compute the average tax rate for the following taxable income amounts

a. $20,000

b. $125,000

c. $350,000

d. $1,000,000

3. Why don’t we calculate the difference in the equity account between the beginning and end of the year and consider that difference as a source or use of cash? Why do we similarly exclude the cash account? Explain.

4. What are free cash flows? Who is likely to be most interested in them? Why?

Answer 1

Answer 1.

Sale price			475000
Purchase cost of drill press		850000
Less: Depreciation for year 1	55%	467500
Less: Depreciation for year 2 (9 Months)	20% x 9/12 = 15%	127500
Book Value of drill press			255000
Profit on sale of drill press			220000

Answer 2.

	Income	15%	25%	30%	35%	Total Tax Payable	Average Tax Rate
a	20000	1500	2500	0	0	4000	0.20
b	125000	1500	10000	22500	0	34000	0.27
c	350000	1500	10000	60000	35000	106500	0.30
d	1000000	1500	10000	60000	262500	334000	0.33