Question

A.

Consider an asset that costs $264,000 and is depreciated straight-line to zero over its 12-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 $33,000.

  

Required :

If the relevant tax rate is 32 percent, what is the aftertax cash flow from the sale of this asset? (Do not round your intermediate calculations.)

rev: 09_18_2012

$634,932.00

$71,720.00

$68,134.00

$75,306.00

$22,440.00

B.

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of $4.050 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will be worthless. The project is estimated to generate $3,600,000 in annual sales, with costs of $1,440,000.

  

Required:

If the tax rate is 35 percent, what is the OCF for this project?

rev: 09_18_2012

$1,782,675

$1,876,500

$2,160,000

$1,970,325

$526,500

Answer 1

a.

Annual depreciation=(Cost-Salvage value)/Useful Life

=(264000/12)=$22000/year

Hence book value as on date of sale=Cost-Accumulated Depreciation

=$264000-(22000*5)=$154000.

Hence loss on sale=(154000-33000)=$121000

Hence after tax cash flow=Sale proceeds+(loss on sale*Tax rate)

=33000+(121000*0.32)

=71720.

b.

Annual depreciation=$4.05million/3

=$1,350,000

Hence OCF=(Sales-Costs)(1-tax rate)+Tax savings on annual depreciation

=(3,600,000-1,440,000)(1-0.35)+(0.35*1,350,000)

=$1,876,500