Eastern Inc. purchases a machine for $70,000. This machine qualifies a

Eastern Inc. purchases a machine for $70,000. This machine 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%.

The firm has a tax rate of 40%. If the machine is sold at the end of two years for $50,000, what is the cash flow from disposal?
A) $50,000
B) $43,440
C) $39,875
D) $33,600

ANSWER

Answer: B
Explanation: B) The four-year sale is at $50,000. To begin with, the book value of the machine must be established to determine if a gain or loss has been incurred at disposal. The depreciation schedule for the $70,000 machine is:
Year 1: $70,000 × 0.2000 = $14,000
Year 2: $70,000 × 0.3200 = $22,400
Accumulated Depreciation = $14,000 + $22,400 = $36,400
Book Value of machine = $70,000 – $36,400 = $33,600
Gain on disposal is $50,000 – $33,600 = $16,400
Tax on Gain = Gain on disposal × Tax rate = $16,400 × 0.40 = $6,560
After-Tax Cash Flow at disposal = $50,000 – $6,560 = $43,440