Sullivan Company plans to acquire a new asset that costs $400,000 and is anticipated to have a salvage value of $30,000 at the end of four years. Sullivan’s policy is to depreciate all assets using straight-line depreciation with no half-year convention. The new asset will replace an old asset that currently has a tax basis of $80,000 and can be sold for $60,000 now. Sullivan will continue to earn the same revenues as with the old asset of $200,000 per year. However, savings in operating costs will be experienced as follows: a total of $120,000 in each of the first three years and $90,000 in the fourth year. Sullivan is subject to a 40 percent tax rate and has an after-tax cost of capital of 10 percent.

A. What is the present value of the depreciation tax shield for the new asset for Year 1?
B. What are the cash flows (net of tax) associated with the disposal of the old asset?
C. What is the investment’s net present value (after tax)?

  • CreatedMarch 11, 2015
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