Question

Q22 Suppose you’re evaluating the asset that costs 50k$ that you expect to sell in five years, suppose further that the tax basis of the asset for tax purposes will be 15k$ after five years and the firm tax rate is 45% and capital gain tax rate is 35% if the firm expects to sell the asset for 60k$ in five years what are the expected cash flows from disposing this asset

Q23 The finance manager is evaluating modern equipment that you expect will reduce expenses by 100k$ during the first year, old machine costs 300k$ and was depreciated using straight line over 10 years with 5 years remaining, the new machine cost 500k$ and will be depreciated using straight line over 10 years if the firm tax rate is 25% what is the expected operating cash in the 1^st year

Answer 1

Solution 22:

Expected sale value of asset = $60,000

Cost of assets = $50,000

Tax basis after 5 years = $15,000

Ordinary income on sale of asset = $50,000 - $15,000 = $35,000

Capital gain on sale of asset = $60,000 - $50,000 = $10,000

Tax on ordinary income = $35,000 *45% = $15,750

Tax on Capital gain = $10,000*35% = $3,500

Expected cash flow from disposing this asset = Sale value - tax on ordinary income - capital gain tax

= $60,000 - $15,750 - $3,500 = $40,750

Solution 23:

Cost of old machine = $300,000

Life = 10 years

Annual depreciation = $300,000/10 = $30,000

Cost o new machine = $500,000

Life = 10 year

Annual depreciation = $500,000/10 = $50,000

If old machine is replaced with new machine than addition depreciation per year = $50,000 - $30,000 = $20,000

Additional tax saving on depreciation = $20,000*25% = $5,000

Reduced expenses for first year after tax = $100,000 (1-0.25) = $75,000

Expected operating cash for 1st year = $75,000 + $5,000 = $80,000