Lecture 31 - Business Finance (ACC501) Lesson 31 Review of...

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161 Business Finance (ACC501) Lesson 31 Review of the Previous Lecture Pro Forma Financial Statements (Cont.) Tax Shield Approach A Closer Look on Net Working Capital Depreciation Topics Under Discussion Depreciation (Cont.) Capital Investment Decisions: A Comprehensive Problem Depreciation Depreciation for an automobile costing $12,000 Year MACRS Percentage Depreciation 1 20.00% $2,400.00 2 32.00 3,840.00 3 19.20 2,304.00 4 11.52 1,382.40 5 11.52 1,382.40 6 5.76 691.20 100.00% $12,000.00 • Book Value versus Market Value Year Beginning Book Value Depreciation Ending Book Value 1 $12,000.00 $2,400.00 $9,600.00 2 9,600.00 3,840.00 5,760.00 3 5,760.00 2,304.00 3,456.00 4 3,456.00 1,382.40 2,073.60 5 2,073.60 1,382.40 691.20 6 691.20 691.20 0.00 Suppose we want to sell the car after 5 years. Based on historical averages, it will be worth, say 25% of the purchase price, i.e. 0.25 x 12,000 = $3,000 If sold on this price we would have to pay taxes on the difference between the price of $3,000 and the book value of $691.20.
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162 so the tax liability would be 0.34 x $2,308.80 = $784.99 The reason for tax payment is that the difference between the market and book value is the excess depreciation that must be recaptured when the asset is sold. This is not a tax on capital gain, because a capital gain occurs if the market price exceeds the original cost. If the book value exceeds the market value, then the difference is treated as a loss for
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Lecture 31 - Business Finance (ACC501) Lesson 31 Review of...

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