Question

The president of Lowell Inc. has asked you to evaluate the proposed acquisition of a new computer. The computer's price is $60,000, and it falls into the MACRS 3-year class (33% in year 1, 45% in year 2, 15% in year 3, and 7% in year 4). Purchase of the computer would require an increase in net operating working capital of $2,000. The computer would increase the firm's before-tax revenues by $20,000 per year but would also increase operating costs by $5,000 per year. The computer is expected to be used for 4 years and then be sold for $25,000. The firm's marginal tax rate is 40 percent, and the project's cost of capital is 14 percent. What is the total value of the terminal year non-operating cash flows (after-tax salvage value + working capital recovered) at the end of Year 4?

	a.	$17,000
	b.	$18,680
	c.	$21,000
	d.	$25,000
	e.	$27,000

Answer 1

A)The book value of asset at end of year 4 will be 0 (fully depreciated )

Gain on sale =Sale value -book value

                 = 25000 - 0

                = $ 25000

Tax on Gain on sale of asset = Gain on sale *tax rate

                            = 25000* 40%

                            = $ 10000

After tax sale value =sale value -Tax on gain on sale of asset

              = 25000-10000

              = 15000

So,

Non operating cash flow or Terminal value at year 4 =After tax sale value +working capital released

                 = 15000 + 2000

                 = $ 17000

correct option is "a" - 17000