Southern Inc. purchases an asset for $150,000. 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%
Southern has a tax rate of 35%. If the asset is sold at the end of four years for $40,000, what is the cash flow from disposal?
A) $36,089
B) $35,072
C) $34,931
D) $33,678
Answer: B
Explanation: B) The four-year sale is at $40,000. 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 $150,000 asset is:
Year 1: $150,000 × 0.2000 = $30,000
Year 2: $150,000 × 0.3200 = $48,000
Year 3: $150,000 × 0.1920 = $28,800
Year 4: $150,000 × 0.1152 = $17,280
Accumulated Depreciation = $30,000 + $48,000 + $28,800 + $17,280 = $124,080
Book Value of asset = $150,000 - $124,080 = $25,920
Gain on disposal is $40,000 - $25,920 = $14,080
Tax on Gain = Gain on disposal × Tax rate = $14,080 × 0.35 = $4,928
After-Tax Cash Flow at disposal = $40,000 - $4,928 = $35,072
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