Kore Industries is analyzing a capital investment proposal for new equipment to produce a product over the next eight years. The analyst is attempting to determine the appropriate “end-of-life” cash flows for the analysis. At the end of eight years, the equipment must be removed from the plant and will have a net book value of zero, a tax basis of $75,000, a cost to remove of $40,000, and scrap salvage value of $10,000. Kore's effective tax rate is 40 percent. What is the appropriate “end-of-life” cash flow related to these items that should be used in the analysis?
a.
$12,000
b.
$(30,000)
c.
$27,000
d.
$(18,000)
Explanation
Choice “a” is correct. $12,000 “end-of-life” cash flow.
The $75,000 loss on disposal is a non-cash reduction in taxable income that will reduce taxes paid by $30,000 (75,000 × 40%).
The cost to remove the equipment is a cash expense that will reduce taxable income by $40,000 and reduce taxes paid by $16,000 (40,000 × 40%), resulting in a net cash expense of $24,000 ($40,000 minus $16,000, or $40,000 × 60%).
The $10,000 salvage value will increase after-tax cash flow by $6,000 (10,000 × 60%).
Can anyone explain this???
Why would the salvage value or cost to remove be affected by tax? I don't see how those would go on the income statement. I would think only the gain or related loss would go on the income statement
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