Question

Blossom Potions, Inc., a pharmaceutical company, bought a machine at a cost of $2 million five years ago that produces pain-reliever medicine. The machine has been depreciated over the past five years, and the current book value is $828,000. The company decides to sell the machine now at its market price of $1 million. The marginal tax rate is 25 percent.

What are the relevant cash flows?

How do they change if the market price of the machine is $600,000 instead?

Answer 1

1. Relevant cash flows:

sale price	1,000,000
less: current book value	(828,000)
gain	172,000
less: tax @25%	(43,000)
relevant cash flow =(sales price - tax)=> (1,000,000-43,000)	957,000

2.If market price is $600,000.

sale price	600,000
less: current book value	(828,000)
loss	(228,000)
tax savings @25%	57,000
relevant cash flow = (sale price + tax savings)	657,000