Question

Consider an asset that costs $690,000 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 $147,000. If the relevant tax rate is 21 percent, what is the aftertax cash flow from the sale of this asset?

Aftertax salvage value=

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

= [$690,000 - $0] / 8 Years

= $86,250 per year

Accumulated Depreciation for the 5 Years

Accumulated Depreciation Expense = Depreciation per year x 5 Years

= $86,250 per year x 5 Years

= $431,250

Book Value of the asset after Year 5

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

= $690,000 - $431,250

= $258,750

Loss on sale of Equipment

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

= $258,750 - $147,000

= $111,750

Here, the asset is sold at a loss of $111,750, 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]

= $147,000 + [$111,750 + 21%]

= $147,000 + 23,467.50

= $170,467.50