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Longer-Run Decisions: Capital Budgeting

I need help for the question below:

A company owned a plot of land that appeared in its fixed assets at its acquisition cost in 1910, which was $10,000. The land was not used. In 2009, the local boys club asked the company to donate the land as the site for a new recreation building. The donation would be a tax deduction of $110,000 which was the current appraised value. The company's tax rate was 40 percent. Some argued that the company would be better off to donate the land to keep it or to sell it for $110,000. Assume that, other than the land, the company's taxable income as well as its accounting income before taxes was $10,000,000.

Required:
How would the company's after-tax cash inflow be affected if (a) it donated the land or (b) it sold the land for $110,000? How would its net income be affected?

Solution Preview

Let's break it down based purely upon the information provided above:

* with income of $10 million at 40% tax rate, the firm would pay normally $4 million in taxes;

* if we sell the property, we would add $110,000 in income to the mix, resulting in $10,110,000 @ 40% for taxes, we now have a tax liability of $4,044,000 (which ...

Solution Summary

Whether to sell or donate becomes a matter of determining the tax consequences of both events, This paper discusses and calculates the tax ramifications of both positions.

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