Northern Co. purchases an asset for $50,000. This asset qualifies as a five-year recovery asset under MACRS, with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%

Question

Northern has a tax rate of 35%. If the asset is sold at the end of four years for $5,000, what is the after-tax cash flow from disposal?
A) $3,535.36
B) $3,408.22
C) $2,592.00
D) $6274.00

Answer 1

Answer: D
Explanation: D) The four-year sale is at $50,000. To begin with, the book value of the asset must be established to determine if a gain or loss has been incurred at disposal. The depreciation schedule for the $50,000 asset is:
Year 1: $50,000 × 0.2000 = $10,000
Year 2: $50,000 × 0.3200 = $16,000
Year 3: $50,000 × 0.1920 = $9,600
Year 4: $50,000 × 0.1152 = $5,760
Accumulated depreciation = $10,000 + $16,000 + $9,600 + $5,760 = $41,360
Book value of asset = $50,000 - $41,360 = $8,640
Loss on disposal (expressing loss as positive number) = $8,640 - $5,000 = $3,640
Tax savings = Loss on disposal × Tax rate = $3,640 × 0.35 = $1,274
After-tax cash flow at disposal = $5,000 + $1,274 = $6,274.00