Winslow,Inc. is considering the purchase of a $225,000 piece of equipment. The equipment is classified as 5-year MACRS property. The company expects to sell the equipment after four years at a price of $50,000. What is the after-tax cash flow from this sale if the tax rate is 35%?

A) $37,036
B) $38,880
C) $46,108
D) $47,770
E) $53,892

Question

Winslow,Inc. is considering the purchase of a $225,000 piece of equipment. The equipment is classified as 5-year MACRS property. The company expects to sell the equipment after four years at a price of $50,000. What is the after-tax cash flow from this sale if the tax rate is 35%?

A) $37,036 
B) $38,880 
C) $46,108 
D) $47,770 
E) $53,892

Quizplus · Accepted Answer

First, we need to calculate the depreciation expense each year using the MACRS schedule for 5-year property, which is as follows:
Year 1: 20%
Year 2: 32%
Year 3: 19.2%
Year 4: 11.52%
Year 5: 11.52%
So, the depreciation expense each year will be:
Year 1: $225,000 x 20% = $45,000
Year 2: ($225,000 - $45,000) x 32% = $57,600
Year 3: ($225,000 - $45,000 - $57,600) x 19.2% = $24,883.20
Year 4: ($225,000 - $45,000 - $57,600 - $24,883.20) x 11.52% = $9,383.92
Year 5: ($225,000 - $45,000 - $57,600 - $24,883.20 - $9,383.92) x 11.52% = $9,383.92
Next, we need to calculate the net book value (NBV) of the equipment at the end of year 4, which is the sale year. The NBV is equal to the original cost of the equipment minus the accumulated depreciation up to that point:
NBV at the end of year 4 = $225,000 - $45,000 - $57,600 - $24,883.20 - $9,383.92 = $87,132.88
The sale of the equipment for $50,000 results in a gain of $50,000 - $87,132.88 = -$37,132.88, which is a loss.
Since the tax rate is 35%, the tax savings from the loss can be calculated as:
Tax savings = Loss x Tax rate = (-$37,132.88) x 35% = $12,996.02
The after-tax cash flow from the sale is equal to the sale price minus the taxes paid on the gain (which is negative in this case) plus the tax savings from the loss:
After-tax cash flow = $50,000 - 0 - $12,996.02 = $37,003.98
Therefore, the best choice is C, which is closest to the calculated after-tax cash flow.