Question

MULTIPLE CHOICE

Assume the following for a piece of equipment assuming​ straight-line depreciation: Purchase price​ $20,000; installation costs of​ $2,500; 4-Yr 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) $15,500 and​ (b) $7,000?

A. ​$14,700; $9,600

B. ​$12,900; $7,800

C. ​$2,000; $1,200

D. ​$8,100; $5,400

Answer 1

Answer: Option A:$14700, $9600

Given

Total Price P=Purchase price + Installation cost =20000+2500=$22500

Salvage value S=$4500

Depreciable base B=P-S=22500-4500=$18000

Depreciation rate d= 1/useful life =1/4=25%

Depreciation each year D= B*d=18000*25%=$4500

So Book value of asset after two years A= P-2*D=22500-2*4500=$13500

Tax rate T=40%

A) if asset is sold at R= $15500

Since we have sold the asset above book value so we have to pay tax on extra amount

So Cash flow = (R-A)*(1-T)+A=(15500-13500)*(1-40%)+13500=$14700

B)

if asset is sold at R= $7000

Since we have sold the asset below book value so we will get tax shield on difference amount

So Cash flow = (R-A)*(T)+R=(13500-7000)*(40%)+7000=$9600