Question

QUESTION 3 (25 marks) A bioengineer is evaluating methods used to apply adhesives onto microporous paper tape that is commonly use after surgery. The machinery costs RM800,000, has no salvage value, and the BTCF estimate is RM300,000 per year for up to 10 years. The effective income tax is 38% and after taxes MARR is 8% per year. The two depreciation methods to consider are: MACRS with n 5 years and Straight-line with n 8 years (neglect the half year convention effect). For a study period of 8 years: Which depreciation method offers the better tax advantage? Please explain and describe your answer briefly. a. (15 marks) b. Demonstrate that the same total taxes are paid for both depreciation methods (10 marks)

Answer 1

Answer:

Part A)

For MACRS depreciation

PV = ATCF/(1+MARR)^t

MARR=8%

t= year in which cash flow occur

For year 1

PV=24680/(1+8%)^1=$228518.52

MACRS Method for depreciation
Year	0	1	2	3	4	5	6	7	8
Initial Investment	800000
BTCF		300000	300000	300000	300000	300000	300000	300000	300000
Depreciation rate		20%	32%	19.20%	11.52%	11.52%	5.76%	0%	0%
Depreciation D		160000	256000	153600	92160	92160	46080	0	0
Taxable Income I= BTCF-D		140000	44000	146400	207840	207840	253920	300000	300000
Tax  @38% T=I*38%		53200	16720	55632	78979.2	78979.2	96489.6	114000	114000
ATCF =BTCF-T		246800	283280	244368	221020.8	221020.8	203510.4	186000	186000
PV of ATCF @ MARR=8%		228518.52	242866.94	193987.20	162456.89	150423.04	128246.07	108529.21	100490.01
NPV= Sum of PV of ATCF-Initial Investment		515517.88

For Straight line method

Depreciation rate=1/project life=12.5%

Straight Line Method for depreciation
Year	0	1	2	3	4	5	6	7	8
Initial Investment	800000
BTCF		300000	300000	300000	300000	300000	300000	300000	300000
Depreciation rate		12.50%	12.50%	12.50%	12.50%	12.50%	12.50%	12.50%	12.50%
Depreciation D		100000	100000	100000	100000	100000	100000	100000	100000
Taxbable Income I= BTCF-D		200000	200000	200000	200000	200000	200000	200000	200000
Tax  @38% T=I*38%		76000	76000	76000	76000	76000	76000	76000	76000
ATCF		224000	224000	224000	224000	224000	224000	224000	224000
PV of ATCF @ MARR=8%		207407.41	192043.90	177818.42	164646.69	152450.64	141158.00	130701.85	121020.23
NPV= Sum of PV of ATCF-Initial Investment		487247.12

Since NPV for MACRS depreciation method is greater than NPV for Straight line method.So MACRS method provides better tax advantage.

Part B)

Total Tax paid in MACRS method=53200+16720+55632+78979.2+78979.2+96489.6+114000+114000=$608000 eq 1

Total Tax paid in Straight Line method =76000+76000+76000+76000+76000+76000+76000+76000=$608000 eq 2

From above equation 1 and 2 it is clear that total tax paid in MACRS and Straight line is same.