Question

Consider an asset that costs $193,600 and is depreciated straight-line to zero over its 9-year tax life. The asset is to be used in a 5-year project; at the end of the project, the asset can be sold for $24,200.

Required :

If the relevant tax rate is 34 percent, what is the aftertax cash flow from the sale of this asset? (Do not round your intermediate calculations.)

Answer 1

The asset has an nine-year useful life and we want to find the BV of the asset after five years. With straight-line depreciation, the depreciation each year will be:

Annual depreciation = $193600/9

Annual depreciation = $21511.11

So, after five years, the accumulated depreciation will be:

Accumulated depreciation = 5($21511.11)

Accumulated depreciation = $107,555.55

The book value at the end of Year 5 is thus:

BV5 = $193600 − 107,555.55

BV5 = $86,044.45

The asset is sold at a loss to book value, so the depreciation tax shield of the loss is recaptured.

Aftertax salvage value = $24,200+ ($86,044.45− 24,200)(0.34)

Aftertax salvage value = $45227.113

To find the taxes on salvage value, remember to use the equation:

Taxes on salvage value = (BV − MV)T

This equation will always give the correct sign for a tax inflow (refund) or outflow (payment).