Question

A question in relation of capital budgeting for a 10 year project.

Say the tax rate for below question is 35%.

The buildings cost $200 000 have an estimated life of 20 years at which time their salvage value would be zero. They are to be depreciated on a straight line (prime cost) basis for tax purposes based on this life. The salvage value of the buildings after 10 years is expected to be $50,000.

The equipment cost $400 000 has an estimated life of 10 years and a zero salvage value. The equipment is to be depreciated on a straight line (prime cost) basis for tax purposes based on this life.

What are the tax implications? Is there is gain or loss and how would you account for this in year 10 of the cash flow. Could you provide an example.

Answer 1

The equipment would be fully depreciated within the period of
the project and it has no salvage value. Hence, it will not give
rise to any cash flow.
For the building the after tax cash flow at EOY 10 would be
as calculated below:
Expected salvage value	$                  50,000
Book value of the building after 10 years = Cost-Accumulated depreciation = 200000-(200000/20)*10 =	$              1,00,000
Loss on disposal	$                  50,000
Tax shield on loss = 50000*35% =	$                  17,500
After tax cash flow from the building at EOY 10 =	$                  67,500
AS the equipment does not have any terminal cash flow
$67,500 will be after tax terminal cash flow from sale of the
fixed assets.