Hello,
I am not sure about the usage of salvage value as cash inflow at the end of project. For example this question, why don't we use salvage value? Do you have any idea?
Thanks,
Özge
Fact Pattern: Calamity Cauliflower Corporation is considering undertaking a capital project.
The company would have to commit $24,000 of working capital in addition to an immediate outlay of $160,000 for new equipment. The project is expected to generate $100,000 of annual income for 10 years. At the end of that time, the new equipment, which will be depreciated on a straight-line basis, is expected to have a salvage value of $10,000.
The existing equipment that would be sold to make room for the project has a historical cost of $220,000 and accumulated depreciation of $208,000. It has an estimated remaining useful life of 2 years and the remaining carrying amount is being depreciated on a straight-line basis. A scrap dealer has agreed to buy it for $8,000.
The company's effective tax rate is 40%.
Question: 8
Calamity Cauliflower's expected depreciation tax shield for the final year of the project i.
A.
$4,000
B.
$0
C.
$2,400
D.
$6,400
Answer (D) is correct.
The old equipment has a remaining useful life of two years, after which it will be fully depreciated and no longer generating depreciation expense. Thus, the depreciation tax shield in the project's last year consists only of the annual depreciation expense on the new equipment ($160,000 historical cost ÷ 10 years = $16,000) times the tax rate (.40), or $6,400.