Question

Pera Inc. is planning to buy a piece of equipment that can be used in a 7-year project. The equipment costs $1,000,000; has a tax life of 10 years, and is depreciated using the straight-line method. The equipment can be sold at the end of 7 years for $400,000. If the marginal tax rate is 40 percent, what is the after-tax cash flow from the sale of this asset (termination value of the equipment)?

In entering your answer, do not use $ sign, use commas to separate thousands, and round to the nearest dollar. For example, if your obtain $30,450.92 then enter 30,451; if you obtain $30,000.00 then enter 30,000

Answer 1

The after tax cash flow is computed as shown below:

= Sales value - tax expenses

Tax expense is computed as follows:

Book value at the end of 7 years is computed as follows:

= Purchase price - Depreciation till 7 years

= $ 1,000,000 - ($ 1,000,000 / 10) x 7

= $ 1,000,000 - $ 700,000

= $ 300,000

So, the profit on sale is computed as follows:

= Sales value - book value

= $ 400,000 - $ 300,000

= $ 100,000

So, the tax expense on profit will be computed as follows:

= Profit amount x tax rate

= $ 100,000 x 40%

= $ 40,000

So, the after tax sales value will be computed as follows:

= $ 400,000 - $ 40,000

= $ 360,000

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