Question

An asset used in a 4-year project falls in the 5-year MACRS class (MACRS Table) for tax purposes. The asset has an acquisition cost of $11,160,000 and will be sold for $2,480,000 at the end of the project.

If the tax rate is 25 percent, what is the aftertax salvage value of the asset?

Answer 1

Under the 5-year class, the rate of depreciation for the first four years is:

• 20%, 32%, 19.2%, 11.52%

Given the initial cost of 11,160,000 the book value of the asset after four years is:

• 11,160,000*(1 - 20% - 32% - 19.2% - 11.52%) = 11,160,000*0.1728 = 1,928,448

If the asset is sold for 2,480,000 which is above the book value, the firm has to pay a 25% tax on the capital gains, so the after-tax salvage value is:

• after-tax salvage value = 2,480,000 - 25% *(2,480,000 - 1,928,448)
• after-tax salvage value = 2,342,112