Final answer:
The aftertax salvage value of the equipment is $61,100, found by taking the salvage value of $94,000 and subtracting the tax of $32,900. The annual operating cash flow is $171,483, calculated by taking the annual pretax savings, adjusting for taxes, and adding the depreciation tax shield.
Step-by-step explanation:
Kolby’s Korndogs is looking to evaluate the financial aspects of a new sausage system investment. To calculate the aftertax salvage value of the equipment, we need to consider the tax effect of selling the asset at the end of its useful life. The annual operating cash flow from the new system is another critical figure needed for the evaluation of the investment.
Aftertax Salvage Value Calculation
The aftertax salvage value can be calculated by taking the salvage value and subtracting any taxes due on the sale of the equipment. The tax due is based on the difference between the salvage value and the book value of the equipment at the end of its life, multiplied by the tax rate. Assuming a corporate tax rate (not provided in the question, so we will use a common rate of 35%), the calculation is as follows:
- Salvage Value: $94,000
- Book Value at the end of 6 years: $0 (straight-line depreciation)
- Taxable Gain on Sale: $94,000 (since the book value is $0)
- Tax Due (35% of $94,000): $32,900
- Aftertax Salvage Value: Salvage Value - Tax Due = $94,000 - $32,900 = $61,100
Annual Operating Cash Flow Calculation
The annual operating cash flow can be determined by starting with the annual pretax savings and subtracting the tax, then adding back the depreciation tax shield. The depreciation tax shield is the depreciation expense multiplied by the tax rate:
- Annual Pretax Savings: $201,000
- Tax on Savings (35% of $201,000): $70,350
- Annual Depreciation Expense: $700,000 / 6 years = $116,667
- Depreciation Tax Shield (35% of $116,667): $40,833
- Annual Operating Cash Flow: ($201,000 - $70,350) + $40,833 = $171,483