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

The after-tax salvage value is calculated by considering the tax implications of the salvage value relative to the book value of the equipment at the time of sale. Since the equipment depreciates over time under the Capital Cost Allowance (CCA) system, its book value decreases each year. At the end of seven years, the book value will be less than the initial purchase price. When the equipment is sold for $7,501, if this amount is higher than the book value, the difference is treated as a recaptured CCA and is taxable. Conversely, if the selling price is lower than the book value, the company can claim a terminal loss, which provides a tax benefit.Given the information, we can't directly calculate the exact book value without the CCA deductions for each year. However, the question seems to imply that we should consider the tax impact on the estimated market value at the time of sale. Assuming the entire $7,501 is taxable at the 35% marginal tax rate (which would be the case if the book value is zero or if the sale price is entirely considered as recaptured CCA), the tax on the sale would be $7,501 * 35% = $2,625.50. Subtracting this tax from the sale price gives an after-tax salvage value of $7,501 - $2,625.50 = $4,875.50. However, since this specific result is not an option and considering the need for a simplified approach as per the question's instruction, the correct answer must be inferred based on the closest match to the expected calculation methodology and the options provided. The correct approach involves recognizing the tax impact on the salvage value, but without the exact CCA calculations provided, we choose the option that conceptually aligns with considering the tax effects on the salvage value. Given the options and the need for a simplified explanation, there seems to be a misunderstanding in the calculation process described above, as none of the options directly match the calculated value. The correct answer should involve recognizing the tax impact on the salvage value, but the provided options and the calculation approach do not align perfectly with standard tax effect calculations on salvage value in a capital budgeting context. Therefore, the explanation aimed to illustrate the concept but may not accurately reflect the intended calculation due to the absence of specific CCA deduction details and the exact book value at the time of sale.