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31 August, 22:31

Assume the following for a piece of equipment assuming straight-line depreciation: Purchase price $20,000; installation costs of $2,500; 4-Yr useful life with an estimated salvage value of $4,500; tax rate 40%; What would be the cash flow from salvage if the asset sold after 2 years for (a) $15,500 and (b) $7,000?

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  1. 31 August, 22:54
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    a. $14,700

    b. $9,600

    Explanation:

    Total cost of the equipment = Purchase price + installation costs = $20,000 + $2,500 = $22,500

    Salvage value = $4,500

    Amount to be depreciated = $22,500 - $4,500 = $18,000

    Depreciation rate = 1 : 4 = 0.25, or 25%

    Annual depreciation = $18,000 * 25% = $4,500

    Equipment book value after 2 years = $22,500 - ($4,500 * 2) = $13,500

    (a) What would be the cash flow from salvage if the asset sold after 2 years for $15,500

    Gross profit on equipment disposal = Sales amount - Equipment book value = $15,500 - $13,500 = $2,000

    Tax = $2,000 * 40% = $800

    Net profit on equipment disposal = $2,000 - $800 = $1,200

    Cash flow = Equipment book value + Net profit on equipment disposal = $13,500 + $1,200 = $14,700

    (b) What would be the cash flow from salvage if the asset sold after 2 years for $7,000

    Loss on equipment disposal = Sales amount - Equipment book value = $7,000 - $13,500 = $6,500

    Tax shield difference = $6,500 * 40% = $2,600

    Cash flow = $7,000 + $2,600 = $9,600
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