Louie's Leisure Products is considering a project which will require the purchase of $1.4 million in new equipment. The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project. Louie's expects to sell the equipment at the end of the project for 20% of its original cost. Annual sales from this project are estimated at $1.2 million. Net working capital equal to 20% of sales will be required to support the project. All of the net working capital will be recouped at the end of the project. The firm desires a minimal 14% rate of return on this project. The tax rate is 34%.
-What is the amount of the after-tax salvage value of the equipment?

Question

Quizplus · Accepted Answer

The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project, so the annual depreciation is $1.4 million / 7 years = $200,000.
At the end of the project, the equipment will be sold for 20% of its original cost, which is 0.2 * $1.4 million = $280,000.
The book value of the equipment at the end of the project is zero, so the taxable gain on the sale is $280,000. After-tax salvage value of the equipment = $280,000 - 0.34 * $280,000 = $184,800.
Therefore, the after-tax salvage value of the equipment is $184,800.

Louie's Leisure Products Is Considering a Project Which Will Require