Your company is considering a replacement of an old delivery van with a new one that is more efficient. The old van cost $30,000 when it was purchased 5 years ago. The old van is being depreciated using the simplified straight line method over a useful life of 10 years. The old van could be sold today for $5,000. The new van has an invoice price of $75,000, and it will cost $5,000 to modify the van to carry the company’s products. Cost savings from use of the new van are expected to be $ 22,000 per year for 5 years. At which time the van will be sold for its estimated salvage value of $15,000. The new van will be depreciated using the simplified straight line method over its 5 year useful life. The company’s statutory rate is 35%. Working capital is expected to increase by $3,000 at the inception of the project, but this amount will be recaptured at the end of year five. What is the tax effect of selling the old machine?
To calculate the tax effect of selling the old van, we need to consider the difference between the book value and the selling price of the van. The book value represents the remaining value of the asset after depreciation.
First, let's calculate the book value of the old van:
Book value = Purchase cost - Accumulated Depreciation
The old van is being depreciated using the simplified straight-line method over a useful life of 10 years. Since 5 years have passed, the accumulated depreciation would be:
Accumulated Depreciation = (Cost / Useful life) * Years
Accumulated Depreciation = (30,000 / 10) * 5 = 15,000
Now, we can calculate the book value:
Book value = 30,000 - 15,000 = 15,000
The old van could be sold today for $5,000, so the difference (gain or loss) between the selling price and the book value needs to be determined.
Difference = Selling Price - Book value
Difference = 5,000 - 15,000 = -10,000
Since the book value is higher than the selling price, there is a loss of $10,000.
To calculate the tax effect of this loss, we need to multiply it by the company's statutory tax rate of 35%:
Tax effect = Loss * Tax rate
Tax effect = -10,000 * 0.35 = -3,500
Therefore, the tax effect of selling the old van is a tax deduction of $3,500.