Question

Problem 3: Disposal of assets Gekko Laboratories had purchased some manufacturing equipment five years ago for a total cost of $3,000,000, and has been depreciating those assets using the MACRS rates (i.e., with a 7-year recovery period). Gekko is currently in the market for newer, more efficient equipment, and has already found a buyer, Fox Pharmaceuticals, who is willing to pay $500,000 for the old equipment. If Gekko Labs, which has an effective tax rate of 35%, disposes of the equipment to Fox, then how much after-tax cash flow will be generated for Gekko? Problem 4: Incremental cash flow A $1,000,000 investment (i.e., manufacturing equipment) is depreciated using the modified accelerated cost recovery system. It requires $150,000 in additional inventory and will increase accounts payable by $50,000. It will generate $400,000 in revenue and $150,000 in cash expenses, annually, and the tax rate is 21%. What is the incremental cash flow in years o, 1, 7 and 8?

Answer 1

3]

loss on sale of equipment = book value - sale price

book value = original cost - accumulated depreciation

after-tax salvage value = salvage value + tax benefit on loss on sale of equipment (the loss is tax deductible, and hence reduces the tax outgo. This is treated as a cash inflow)

tax benefit = loss on sale of equipment * tax rate

book value = $3,000,000 - $2,330,700 = $669,300

loss on sale of equipment = $669,300 - $500,000 = $169,300

tax benefit = $169,300 * 35% = $59,255

after-tax salvage value = $500,000 + $59,255 = $559,255

1 Year A B C Depreciation Depreciation rate rate amount 14.29% $ 428,700 24.49% $ 734,700 17.49% $ 524,700 12.49% $ 374,700 8.93% $ 267,900 Total $ 2,330,700