Witherspoon, Inc. is considering purchasing a piece of equipment for $43,701. The company has a 35% marginal tax rate and the equipment belongs in a 30% CCA class. At the end of seven years,
The company intends to sell the equipment. The estimated market value of the equipment at that
Time is $7,501. What after-tax salvage value should be placed on the equipment as the company
Does its capital budgeting analysis on this potential purchase? (For simplicity, you may assume that
The CCA pool will terminate when the asset is sold.)

Question

Quizplus · Accepted Answer

To find the after-tax salvage value, we need to calculate the tax savings from the CCA deductions and the tax on the recaptured CCA.

The CCA for this class is 30%, so the maximum amount that can be claimed as a deduction each year is $13,110 ($43,701 x 30%). Since the equipment will be used for 7 years, the total CCA claimed will be $91,770 ($13,110 x 7).

The tax savings from the CCA deductions will be 35% x $91,770 = $32,120.50.

When the equipment is sold for $7,501, the company will need to recapture the CCA previously claimed as income. The recapture amount will be the lesser of the sale price or the original cost ($43,701). In this case, the recapture amount will be $7,501.

The tax on the recaptured CCA will be 35% x $7,501 = $2,625.35.

The after-tax salvage value of the equipment can be calculated as follows:

After-tax salvage value = Sale price - (Tax on recaptured CCA - Tax savings from CCA deductions)
After-tax salvage value = $7,501 - ($2,625.35 - $32,120.50)
After-tax salvage value = $6,405.15

Therefore, the best choice is C) $6,405.