Question

Assume the following for a piece of equipment assuming straight­line depreciation: Purchase price $20,000; installation costs of $2,500; 4­Yr useful life with an estimated salvage value of $4,500; tax rate 40%; What would be the cash flow from salvage if the asset sold after 2 years for (a) $11,500 and (b) $7,000?

a) $15,300, $6,200

b) $7,800, $11,700

c) $11,700, $7,800

d) $10,500, $7,800

Answer 1

Salvage value if asset sold for $ 11,500 is computed as follows:

= Sales value - Tax on profit on sale

Tax on profit on sale is computed as follows:

= (Sales value - depreciation) x tax rate

= ($ 11,500 - [ [ ($ 22,500 - $ 4,500) / 4 ] x 2 ] ) x 40%

= $ 1,000

So, the value will be as follows:

= $ 11,500 - $ 1,000

= $ 10,500

Salvage value if asset sold for $ 7,000 is computed as follows:

= Sales value - Tax on profit on sale

Tax on profit on sale is computed as follows:

= (Sales value - book value) x tax rate

Book value is computed as follows:

= ($ 22,500 - [ [ ($ 22,500 - $ 4,500) / 4 ] x 2 ] )

= $ 13,500

So, the profit on sale will be as follows:

= $ 7,000 - 13,500)

= $ 7,800

So, the correct answer is option d.

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