Do you not include salvage value when calculating depreciation for tax purposes?
This is a Becker question.
The Moore Corporation is considering the acquisition of a new machine. The machine can be purchased for $90,000; it will cost $6,000 to transport to Moore's plant and $9,000 to install. It is estimated that the machine will last 10 years, and it is expected to have an estimated salvage value of $5,000. Over its 10-year life, the machine is expected to produce 2,000 units per year with a selling price of $500 and combined material and labor costs of $450 per unit. Federal tax regulations permit machines of this type to be depreciated using the straight-line method over 5 years with no consideration for salvage value. Moore has a marginal tax rate of 40 percent.
What is the net cash flow for the third year that Moore Corporation should use in a capital budgeting analysis?
a.
$47,400
b.
$68,400
c.
$53,700
d.
$64,200
Explanation
Choice “b” is correct. $68,400 net cash flow for the third year.
$90,000 + 6,000 + 9,000
5 years
=
$105,000 tax
5 years
=
$21,000 tax depreciation
Unit
In year 3:
Qty
Value
Tax Calc
Cash Flow
Cash inflow from sales
(2,000 × $500)
=
$1,000,000
$1,000,000
Cash outflow for materials & labor
(2,000 × $450)
=
(900,000)
(900,000)
Cash inflow from operations in year 3
100,000
100,000
Less tax
Depreciation expense
(21,000)
Taxable income
79,000
Marginal tax rate
× 40%
Tax to be paid
$31,600
31,600
Net cash flow in year 3 after taxes
$68,400
Alternate Computation:
Cash flow: 1,000,000 − 900,000 = 100,000 × (1 − .4) =
$60,000
After-tax cash flow
Depreciation tax shield: 21,000 × 40%
8,400
Tax shield
$68,400
After-tax cash flow
.