Question

Computing the terminal-year fcf: babaloo nightclubs. purchased a disco mirror that currently has a book value of $10,000. if babaloo sells the disco mirror for $500 today, then what is the amount of cash that it will net after taxes if the firm is subject to a 39 percent marginal tax rate?

a. $500
b. $3,705
c. $4,205
d. $9,500

Answer 1

After accounting for the tax benefit from the loss of selling the disco mirror, Babaloo Nightclubs will net $4,205. Therefore, the most appropriate option is C.

Step-by-step explanation:

To compute the terminal-year free cash flow (FCF) after selling the disco mirror, we need to calculate the tax implications of the sale. The mirror has a book value of $10,000 and the sale price is $500. Assuming a 39 percent marginal tax rate, the tax will be levied on the loss (book value minus sale price). The loss on sale is $10,000 - $500 = $9,500. At a 39 percent tax rate, the tax benefit (tax shield) from the loss is $9,500 x 39% = $3,705. Therefore, Babaloo will net the sale price of the mirror plus the tax shield: $500 (sale price) + $3,705 (tax shield) = $4,205.