Question

A 296500$ tractor-trailer is being depreciated by the straight line method over five years to a final Book Value (BV) of zero. After three years the trailer is sold for

a) 249830 $ (2 points)

b) 80460$. (2 points)

If the effective income tax rate is 52% what is the net cash inflow from the sale for situation (a) and situation (b)? (tax saving is permitted. )

Answer 1

If the tractor is being depreciated through SLM to 0 over 5 years, then the annual depreciataion is 1/5 or 20% of the cost, i.e. $296500

Therefore, annual depreciation = 0.2 x 269500 = 59300

So after 3 years the depreciation would be 3 x 59300 = 177900

This implies that the book value of the asset would be 296500 -177900 = 118600

Now we need to compare it to the sale price under each situation. If the sale price is greater, then the tractor is sold for profit, which will be taxed. While if the sale price is lower, then the tractor is sold for a loss, which will lead to tax savings.

a)

• Profit = Sale price - Book value
  • Profit = 249830 - 118600
  • Profit = 131230
• Tax on profit = Tax rate x Profit
  • Tax on profit = 0.52 x 131230
  • Tax on profit = 68239.6
• Net CF = Sale price - Tax on profit
  • Net CF = 249830-68239.6
  • Net CF = $181590.4

b)

• Profit = Sale price - Book value
  • Profit = 80460- 118600
  • Profit = -38140
  • Negative profit is a loss
• Tax savings on loss = Tax rate x loss
  • Tax savings on loss = 0.52 x 38140
  • Tax savings on loss = 19832.8
• Net CF = Sale price + Tax savings on loss
  • Net CF = 80460+19832.8
  • Net CF = $100292.8