Question

Problem 10-7 Calculating Salvage Value [LO1] Consider an asset that costs $595,000 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 $180,000. If the relevant tax rate is 34 percent, what is the aftertax cash flow from the sale of this asset? Aftertax salvage value

Answer 1

The asset has a useful life of seven years and we want to find the BV of the asset after five years. Withstraight-line depreciation, the depreciation each year will be:

Annual depreciation = $595,000 / 7

Annual depreciation = $85,000

So, after five years, the accumulated depreciation will be:

Accumulated depreciation = 5($85,000)

Accumulated depreciation = $425,000

The book value at the end of Year 5 is thus:

BV₅ = $595,000 − 425,000

BV₅ = $170,000

The asset is sold at a loss to book value, so the depreciation tax shield of the loss is recaptured.

Aftertax salvage value = $180,000 + ($170,000 - $180,000)0.34

Aftertax salvage value = $176,600