Question

Consider an asset that costs $812,000 and is depreciated straight-line to zero over its seven 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 $154,000. If the relevant tax rate is 21 percent, what is the aftertax cash flow from the sale of this asset? (Do not round intermediate calculations.)

Answer 1

After-tax Salvage Value

Annual Depreciation expense using straight line method

Depreciation expense using straight line method = [Cost of the asset – Salvage Value] / 8 Years

= [$812,000 - $0] / 7 Years

= $812,000 / 7 Years

= $116,000 per year

Accumulated Depreciation for the 5 Years

Accumulated Depreciation Expense = Depreciation per year x 5 Years

= $116,000 per year x 5 Years

= $580,000

Book Value of the asset after Year 5

Book Value of the asset after Year 5 = Cost of the asset – Accumulated Depreciation

= $812,000 - $580,000

= $232,000

Loss on sale of Equipment

Loss on sale of Equipment = Book Value of the asset – Sale Proceeds

= $232,000 - $154,000

= $78,000

Here, the asset is sold at a loss of $78,000, therefore, there would be a depreciation tax shield of the loss

The After-tax salvage Value

After-tax salvage value = Sale Proceeds + [Loss on sale x Tax Rate]

= $154,000 + [$78,000 x 21%]

= $154,000 + $16,380

= $170,380

“Hence, the after-tax cash flow from the sale of this asset will be $170,380”