Your firm purchased machinery for $10 million. The machinery falls into asset class 38, which has a CCA rate of 25 percent. The project will end after 5 years. If the equipment can be sold for $4 million at the completion of the project and your firm's tax rate is 35 percent, what is the after-tax cash flow from the sale of the machinery? Assume that the firm has no other assets in Class 38 and the asset class will be terminated upon the sale of the machinery.
answer: $3568994.14
please show detailed solution
To calculate the after-tax cash flow from the sale of the machinery, we need to consider the concept of Capital Cost Allowance (CCA) and the tax rate. Here's how we can find the solution step-by-step:
1. Calculate the depreciation expense using the CCA rate. Since the machinery falls into asset class 38 with a CCA rate of 25 percent, the annual depreciation expense can be calculated as follows:
Depreciation Expense = Purchase Cost * CCA Rate
= $10,000,000 * 0.25
= $2,500,000 per year
2. Determine the unclaimed CCA. Since the project will end after 5 years, there will be unclaimed CCA at the end of the project. Multiply the remaining years by the annual depreciation expense:
Unclaimed CCA = Remaining Years * Depreciation Expense
= 5 * $2,500,000
= $12,500,000
3. Calculate the taxable income from the sale of the machinery. This is the selling price minus the net book value (NBV). The NBV is the initial cost of the machinery minus the total accumulated depreciation. In this case, since there are no other assets in Class 38 and the class will be terminated, the total accumulated depreciation will be equal to the unclaimed CCA:
Taxable Income = Selling Price - NBV
= $4,000,000 - ($10,000,000 - $12,500,000)
= $4,000,000 - (-$2,500,000)
= $6,500,000
4. Calculate the tax expense. Multiply the taxable income by the tax rate:
Tax Expense = Taxable Income * Tax Rate
= $6,500,000 * 0.35
= $2,275,000
5. Calculate the after-tax cash flow. The after-tax cash flow is the selling price minus the tax expense:
After-Tax Cash Flow = Selling Price - Tax Expense
= $4,000,000 - $2,275,000
= $1,725,000
Therefore, the after-tax cash flow from the sale of the machinery is $1,725,000.