Principles of Managerial Finance

368 PART 3 Long-Term Investment Decisions

FIGURE 8.5 Taxable Income from Sale of Asset

Taxable income from sale of asset at various sale prices for Hudson Industries

Initial

Purchase

Price

Book

Value

$100,000

$70,000

$48,000

$30,000

$0

$110,000 Capital Gain($10,000)

Recaptured

Depreciation

($52,000)

$110,000 $70,000 $48,000

Sale Price

$30,000

Recaptured

Depreciation

($22,000) No Gain

or Loss Loss

($18,000)

6. As noted in Chapter 1, the tax law provides detailed procedures for using tax loss carrybacks/carryforwards.
   Application of such procedures to capital budgeting is beyond the scope of this text, and they are therefore ignored
   in subsequent discussions.


7. Occasionally, this cash outflow is intentionally ignored to enhance the attractiveness of a proposed investment
   and thereby improve its likelihood of acceptance. Similar intentional omissions and/or overly optimistic estimates
   are sometimes made to enhance project acceptance. The presence of formal review and analysis procedures should
   help the firm to ensure that capital budgeting cash flow estimates are realistic and unbiased and that the “best” proj-
   ects—those that make the maximum contribution to owner wealth—are accepted.

net working capital
The amount by which a firm’s
current assets exceed its current
liabilities.

sale price in Figure 8.5. Becauseno tax results from selling an asset for its book

value,there is no tax effect on the initial investment in the new asset.

The sale of the asset for less than its book value If Hudson sells the asset for

$30,000, it experiences a loss of $18,000 ($48,000$30,000), as shown under

the $30,000 sale price in Figure 8.5. If this is a depreciable asset used in the busi-

ness, the loss may be used to offset ordinary operating income. If the asset isnot

depreciable or isnotused in the business, the loss can be used only to offset capital

gains. In either case, the loss will save the firm $7,200 ($18,0000.40) in taxes.

And, if current operating earnings or capital gains are not sufficient to offset the

loss, the firm may be able to apply these losses to prior or future years’ taxes.^6

Change in Net Working Capital^7

Net working capitalis the amount by which a firm’s current assets exceed its cur-

rent liabilities. This topic is treated in depth in Chapter 14, but at this point it is

important to note that changes in net working capital often accompany capital

expenditure decisions. If a firm acquires new machinery to expand its level of

operations, it will experience an increase in levels of cash, accounts receivable,

inventories, accounts payable, and accruals. These increases result from the need