Question

1. Miller Corp. is considering a new three-year expansion project that requires an initial fixed asset investment of $900,000. The fixed asset will be depreciated by the straight-line method over its three-year useful life. And, the salvage value is zero. Assume the tax rate is 35%. What is the depreciation tax shield per year?

2. Following #1, we’ll assume the straight-line depreciation is used. And, the salvage value is zero. The project is estimated to generate $500,000 in annual sales, with costs of $150,000. If the tax rate is 35%, what is the operating cash flow (OCF) per year for this project?

3. Following #1, we’ll assume the straight-line depreciation is used; but, now we’ll assume the salvage value is $30,000. The company could sell the old equipment for $50,000 at the end of the project. Assume the tax rate is 35%.

What is the after-tax salvage value of selling the old equipment?

Answer 1

Answer : 1.) Calculation of Depreciation Tax Shield

Depreciation tax shield = Annual Depreciation * Tax rate

Annual Depreciation = Cost of Equipment / Number of year of useful life

= 900,000 / 3

= 300,000

Depreciation tax shield per year = 300,000 * 35%

= 105,000

Answer :2 ) Calculation of Operating Cash Flow each Year

Operating cash Flow = [(Sales - Cost) * (1 - tax rate)] + Depreciation tax shield per year

= [(500,000 - 150,000) * (1 - 0.35)] + 105000

= 227500 + 105000

= 332,500

Answer : 3) Calculation of After tax salvage Value

After tax salvage Value = Salvage Value - Tax on Gain on Sale

Tax on Gain on Sale = Gain on Sale * Tax rate

Gain on Sale = Salvage Value - Book Value

Book Value in this case will be 30000 as the equipment has been depreciated to 30000

Gain on Sale = 50000 - 30000

= 20000

Tax on Gain on Sale = 20000 * 35%

= 7000

After tax salvage Value = 50000 - 7000

= 43000