Final answer:
The terminal value of the investment is found by calculating the tax shield on a tax loss. The salvage value is combined with the tax shield, which gives a terminal value of $3,700. The correct answer is A. $3,700.
Step-by-step explanation:
To calculate the terminal value of a long-term investment, one must consider the salvage value, the adjusted tax value, and the tax rate. In this scenario, the expected salvage value is $1,000 and the adjusted tax value (book value) of the asset is $10,000. With a tax rate of 30 percent, we would calculate the tax implication on the disposal of the asset by first finding the tax base, which is the difference between salvage value and book value:
Salvage Value - Adjusted Tax Value = $1,000 - $10,000 = -$9,000
As the salvage value is less than the book value, there is a tax loss, which means there's no tax payable but rather a tax shield due to the loss. In this situation, the terminal value is equal to the salvage value plus the tax shield (i.e., loss multiplied by the tax rate):
Terminal Value = Salvage Value + Tax Shield
Tax Shield = Tax Loss × Tax Rate
Tax Loss = Adjusted Tax Value - Salvage Value
Tax Shield = ($10,000 - $1,000) × 30% = $2,700
Therefore, Terminal Value = $1,000 + $2,700 = $3,700.
The correct answer is A. $3,700.