Consider
an asset that costs $712,000 and is depreciated straight-line to zero
over its eight-year tax life. The asset is to be used in a five-year
project; at the end of the project, the asset can be sold for $184,000.
If the relevant tax rate is 35 percent, what is the aftertax cash flow
from the sale of this asset?
Explanation:
The
asset has an eight-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 = $712,000/8 |
| Annual depreciation = $89,000 |
| So, after five years, the accumulated depreciation will be: |
| Accumulated depreciation = 5($89,000) |
| Accumulated depreciation = $445,000 |
| The book value at the end of Year 5 is thus: |
| BV5 = $712,000 − 445,000 |
| BV5 = $267,000 |
| The asset is sold at a loss to book value, so the depreciation tax shield of the loss is recaptured. |
| Aftertax salvage value = $184,000 + ($267,000 − 184,000)(0.35) |
| Aftertax salvage value = $213,050 |
| 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).
