Copyright

Laurence bought a classic car for $40,000 as a business investment opportunity. He was allowed to...

Question:

Laurence bought a classic car for $40,000 as a business investment opportunity. He was allowed to depreciate it over 10 years and take the amount as a business tax deduction on his return. At the end of 10 years, the car was sold for $40,000. If Laurence was in the 38 percent marginal tax bracket and could earn 8 percent after tax on the cash flow generated, what was his cumulative cash benefit after sale on this transaction? (Round answers to the nearest whole number. )

(a) Yearly Deductible Depreciation =

(b) Yearly Tax Benefit =

(c) Cumulative Tax Benefit (future value) =

(d) Tax on $40,000 Capital Gain =

(e) Net Cash earned (c - d) =

Depreciation Expense:

The depreciation expense is the recovering cost on the fixed assets allocated by a specific method during the expected lifetime of the asset. In accounting, this is the qualified expenses for lowering the taxable income. In financial analysis, it is treated as the non-cash expense, which will increase the cash flow.

Answer and Explanation:

a. Yearly deductible depreciation:

Assume the straight line method was allowed in this case.

{eq}Yearly depreciation = \frac{\$40,000}{10} = $4,000{/eq}

b. Yearly tax benefit:

Yearly tax benefit = $4,000 x 38% = $1,520

c. Cumulative tax benefit:

Since he will earn 8% after-tax on the cash flow generated. We will treat the annual savings of $1,520 as the annuity. The future value of this stream of cash inflows will be the cumulative benefit.

{eq}FV = \displaystyle $1,520\times\frac{(1+8\%)^{10}-1}{8\%} = $22,019.57 {/eq}

d. Tax on $40,000 at year 10:

Tax liability = $40,000 x 38% = $15,200

e. Net cash earned:

Net cash earned = $22,019.57 - $15,200 = $6,819.57


Learn more about this topic:

Loading...
How to Calculate Depreciation Expense: Definition & Formula

from Financial Accounting: Help and Review

Chapter 5 / Lesson 14
184K

Related to this Question

Explore our homework questions and answers library