Morgado Inc. has provided the following data to be used in evaluating a proposed investment project: The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 5 years without any reduction for salvage value. The company uses a discount rate of 19%.
-When computing the net present value of the project,what is the after-tax cash flow from the salvage value in the final year?

Question

Morgado Inc. has provided the following data to be used in evaluating a proposed investment project:  The company's tax rate is 30%. For tax purposes, the entire initial investment will be depreciated over 5 years without any reduction for salvage value. The company uses a discount rate of 19%.
-When computing the net present value of the project,what is the after-tax cash flow from the salvage value in the final year?

Quizplus · Accepted Answer

The after-tax salvage value is computed as follows:
Salvage value = Market value - book value
Market value = $15,000
Book value = Cost - cumulative depreciation
Cost = $60,000
Depreciation = ($60,000 - $15,000) / 5 years = $9,000 per year
Cumulative depreciation after four years = $9,000 x 4 = $36,000
Book value = $60,000 - $36,000 = $24,000

Therefore, salvage value = $15,000 - $24,000 = -$9,000 (there is a loss)

However, the loss can be used to reduce taxable income, resulting in a tax benefit. Assuming a tax rate of 40%, the tax benefit is:

Tax benefit = $9,000 x 40% = $3,600

Therefore, the after-tax salvage value is:

After-tax salvage value = Salvage value + Tax benefit
After-tax salvage value = -$9,000 + $3,600 = -$5,400

Since the salvage value is negative, there is no after-tax cash flow. Therefore, the answer is D) 0.