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  • 1.  Should salvage value be deducted from tax shield? Bison Inc. is considering the purchase of a new automatic machine to replace its current oldfashioned machine.

    Posted 10-15-2022 08:48 AM
    Bison Inc. is considering the purchase of a new automatic machine to replace its current oldfashioned machine. Bison's effective tax rate is 40%, and its cost of capital is 8%. Data regarding
    the existing and new machines are presented below.
    Existing New
    Machine Machine
    Original cost $100,000 $180,000
    Installation costs 0 25,000
    Freight and insurance 0 9,000
    Expected end salvage value 0 14,000
    Depreciation method straight-line straight-line
    Expected useful life 10 years 5 years
    The existing machine has been in service for five years and could be sold currently for $30,000.
    Bison expects to save annual pre-tax labor costs of $50,000 from the new machine.
    If the new machine is purchased, the incremental cash flows for the second year would be
    a. $18,000.
    b. $30,000.
    c. $38,000.
    d. $42,000.

    The answer is $42,000 as below:
    After-tax cash savings $50,000 x .6 = $30,000
    Tax shield/new equipment ($180,000+25,000+9,000-14,000) ÷ 5 x .4 = 16,000
    - Loss of old tax shield - ($100,000 ÷ 10) x .4 = - 4,000
    Incremental Cash flow $42,000

    Why the salvage value was deducted from tax shield????

    ------------------------------
    Noor Jarrar
    Student
    Amman
    Jordan
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  • 2.  RE: Should salvage value be deducted from tax shield? Bison Inc. is considering the purchase of a new automatic machine to replace its current oldfashioned machine.

    Posted 10-15-2022 05:04 PM
    Hi Noor,

    The answer to your question (see below source): 

    the key word there is "incremental". Incremental = the change in anything.  For the tax shield portion, you are swapping out one tax shield for another during the first five year life of the new machine.

    If the company does not replace the existing machine, then the company will still enjoy the tax $2000 (5,000 x 40%) shield from the old machine for every year of the remaining life of the machine which in this case is 5 years. 


    If the company replaces the old machine it will no longer enjoy the old tax shield which could have been enjoyed over the 5 years remaining useful life of the old machine. The incremental change is the difference between the two tax shields.



    ------------------------------
    Mark Anthony Pusing
    Accountant
    Blue Steel Factory W.L.L.
    Doha
    Qatar
    ------------------------------

    Original Message


  • 3.  RE: Should salvage value be deducted from tax shield? Bison Inc. is considering the purchase of a new automatic machine to replace its current oldfashioned machine.

    Posted 10-15-2022 05:10 PM
    Hi Mark, 

    Thanks for explaining the question but I am asking why $14,000 salvage value was deducted when calculating the depreciation shield. Usually salvage value is deductible for tax depreciation. 

    Thanks!

    ------------------------------
    Noor Jarrar
    Student
    Amman
    Jordan
    ------------------------------

    Original Message


  • 4.  RE: Should salvage value be deducted from tax shield? Bison Inc. is considering the purchase of a new automatic machine to replace its current oldfashioned machine.

    Posted 10-17-2022 05:18 PM
    Why the salvage value was deducted from tax shield????

    It is the selling price of the equipment and the amount is going to be taxed >>>    after tax salvage value

    ------------------------------
    Idrees Bino
    Administrative
    Amman - Jordan
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    Original Message


  • 5.  RE: Should salvage value be deducted from tax shield? Bison Inc. is considering the purchase of a new automatic machine to replace its current oldfashioned machine.

    Posted 10-15-2022 05:07 PM
    Corrected version:

    Hi Noor, 

    The answer to your question (see below source):

    the key word there is "incremental". Incremental = the change in anything.  For the tax shield portion, you are swapping out one tax shield for another during the first five year life of the new machine.

    If the company does not replace the existing machine, then the company will still enjoy the tax $4000 (10,000 x 40%) shield from the old machine for every year of the remaining life of the machine which in this case is 5 years. 


    If the company replaces the old machine it will no longer enjoy the old tax shield which could have been enjoyed over the 5 years remaining useful life of the old machine. The incremental change is the difference between the two tax shields.



    ------------------------------
    Mark Anthony Pusing
    Accountant
    Blue Steel Factory W.L.L.
    Doha
    Qatar
    ------------------------------

    Original Message


  • 6.  RE: Should salvage value be deducted from tax shield? Bison Inc. is considering the purchase of a new automatic machine to replace its current oldfashioned machine.

    Posted 10-20-2022 06:10 AM
    HOCK has verified with the ICMA that salvage (or residual) value is not subtracted from the cost
    to calculate the depreciable base for purposes of calculating depreciation and the depreciation
    tax shield in capital budgeting. It appears, however, that other study guides (not HOCK-related) do
    not consistently teach this rule correctly, which has led to some confusion. Do not be concerned about
    this discrepancy. Rest assured that HOCK has presented the correct information.

    ------------------------------
    Adnan
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    Original Message