Question

Pear Orchards is evaluating a new project that will require equipment of $261,000. 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 $74,900. However, the company plans to keep the equipment for a different project in another state. The tax rate is 40 percent. What aftertax salvage value should the company use when evaluating the current project?

Answer 1

Depreciation in year 1 is :

= 20% * $261,000

= $52,200

The depreciation in year 2 is :

= 32% * $ 261,000

= $83,520

The depreciation in year 3 is :

= 19.2% * $261,000

= $50,112

The depreciation in year 4 is :

= 11.52% * $261,000

= $300,67.2

So, the book value at the end of year 4 is =

= ( $261,000 - $ 52,200- $83,520 - $50,112 - $300,67.2)

= $45100.8

So, the after tax salvage value is :

= Salvage value - ( salvage value - book value) * tax rate

= $74,900 - ( $74,900 - $45100.8) *0.4

= $ 62,980.32

= $62,980 ( rounded off to two decimal places)