Accounting Test Questions on Depreciation, and After-Tax Salvage Value

ADMINISTRATIVE MATTERS:
- Project #3 is due on Friday, April 18 at 4PM in 340
Wohlers.
- Office hours on Thursday at 3:30 in 170 Wohlers.

TODAY:
• Chapter 12 (CF Estimation)
• Web Appendix 12B (Replacement)
• Web Appendix 12F (Unequal Lives)
PROBLEM 3 (Chapter 12)
Kennedy Air Services is now in the final year of a project.
The equipment originally cost $20 million, of which 80 percent has been depreciated. Kennedy can sell the used equipment today for $5 million, and its tax rate is 40 percent.
What is the equipment’s after tax net salvage value.
Book Value (BV) = (1 – 0.8) x $20 = $4 million
Market Value (MV) = $5 million
Additional Taxable Income = MV – BV = $1 million
Additional Taxes = 0.4 x $1 = $0.4 million
After tax salvage value = $4 - $0.4 = $3.6 million
Or use the following formula:
After-tax Salvage Value = MV – T x (MV – BV)

1

PROBLEM 6 (Chapter 12)
You must evaluate a proposed spectrometer for the R&D department. The base price is $140,000, and it would cost another $30,000 to modify the equipment for the special use by the firm. The equipment falls under 3-year MACRS class and would be sold after 3 years for $60,000. The applicable rates are 33, 45, 15, and 7 percent. The equipment would require an $8,000 increase in working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $50,000 per year in before-tax labor costs. The firm’s marginal tax rate is 40 percent.

b. What are the net operating CFs in Years 1, 2, and 3?
Year
Depr. %
Depreciation
(Base=$170)

1
.33
$56.1

2
.45
$76.5

3
.15
$25.5

Cost-savings
-Depr

$50
$56.1

$50
$76.5

$50
$25.5

Taxable Inc.
-Taxes

a. What is the net cost of the spectrometer, that is the Year 0 project CF?
Base price
Modification
Increase in NOWC
Cash outlay for new machine

2

-$6.1
-$2.44

-$26.5
-$10.6

$24.5
$9.8

Net Income

-$3.66

-$15.9

$14.7

$56.1