Question

Pear Orchards is evaluating a new project that will require equipment of $247,000. The equipment will be depreciated on a 5-year MACRS schedule. The annual depreciation percentages are 20.00 percent, 32.00 percent, 19.20 percent, 11.52 percent, and 11.52 percent, respectively. The company plans to shut down the project after 4 years. At that time, the equipment could be sold for $65,800. However, the company plans to keep the equipment for a different project in another state. The tax rate is 35 percent. What aftertax salvage value should the company use when evaluating the current project?

Multiple Choice

$73,891

$42,682

$65,800

$57,709

$0

Answer 1

First of all we shall calculate the depreciation of equipment for four years since after that the company plans to shut down the plant and we have to find the salvage value in relation to evaluating the current project.

Year	Depreciation Computation (Original Purchase Price x Depreciation Rate)	Depreciation Amount	Computation of closing value of Equipment	Closing value of Equipment
1	$ 247,000 x 20%	$ 49,400	= 247,000 - 49,400	197,600
2	$ 247,000 x 32%	$ 79,040	=197,600 - 79,040	118,560
3	$ 247,000 x 19.20%	$ 47,424	= 118560 - 47,424	71,136
4	$ 247,000 x 11.52%	28,454.4	= 71,136 - 28,454.4	42,681.6

As we can see that the value of equipment after 4 years shall be $ 42,681.60, however we are able to sell it for $ 65,800, which means we are able to generate a profit of $ 65,800 - $ 42,681.60 = $ 23,118.40

In this profit we have to pay tax equal to the profit's amount multiply by the tax rate which is 35%

So our tax would come out to be = $ 23,118.40 x 35% = $ 8091.44

So our salvage value after tax when evaluating the current project would be Salvage value less tax paid

= $ 65,800 - $ 8091.44

= $ 57,708.56 or $ 57,709 Approximately

So our best answer is option d

Feel free to ask in case of any query regarding this question.