Question

Southwest Airlines just bought a new jet for $38,000,000. The jet falls into the 7-year MACRS category, with the following depreciation rates (half-year convention):

Year	1	2	3	4	5	6	7	8
Depr. rate	14.29%	24.49%	17.49%	12.49%	8.93%	8.92%	8.93%	4.46%

The jet can be sold for $30,400,000 after 5 years. The company has a marginal tax rate of 34%.

1. What is the book value at the end of year 5?

2. What is the after-tax salvage value at the end of year 5?

Answer 1

1. First we can add the depreciation rates till year 5. That is 14.29% + 24.49% + 17.49% + 12.49% + 8.93% = 77.69%

When the asset is depreciated 77.69%, then book value = 100% - 77.69% = 22.31%

Therefore,

Book value = $38,000,000 * 22.31%

= $8,477,800

2. After tax salvage value:

In simple words, it means Sale price minus tax.

So first we need to find tax. Now tax is calculated on gain on sale.

Gain = Sale price - Book Value
= $30,400,000 - $8,477,800
= $21,922,200

Tax = Gain * Tax rate
=  $21,922,200 * 34%
=  $7,453,548

Therefore,

After-tax Salvage value = Sale price - Tax
=$30,400,000 - $7,453,548
= $22,946,452