Question

Marko* Manufscluring recetly spenl S18.5 rnilion to purthase samI:euipment used in the marufacture of disk dives. The firm expects that this equipment wl ae useful lif af years, and its alarol tax rat is 21%. The crpay pans a use straight-in a. Wrial is tet annual deprecialion expens associaled wilh Ihis euuoment? b. What is the anrusl depreciation tax ehield? c. Rather men atraghiH ne depre ation, suppoee Marko I use he MACRS depreda: on metoc 1or ชาe tve-year ife of the oroperty. Calculate the cep e a on ax hied each year for tile equipment under thia accelerated depreciation achedule d. t Markow has a choce batween straight-Ine and MMACRS depreciaion achedules, end ts marginal corporate tex rate is execed to remain constent, which schedule should t choose hy? e How might your สาร er to part d change if Mar o enticipates 1hat its marginal oor orate tRX rate wil in ease substentially over next five gas f. undnrtne T a 2 1 7 Maricovhasthe叩tinn o takn 100 Banus nepr cation in he yRar n which th, enui nmnnt i put into use. This means hat n hat nar, Markov nud akn1 e ul deneciaton x ense e lavalant n he cost o bu ing ha a llmert. Rather han strain -inn deprecatin, suppasc Mak will use thr bonus drareciatian methar. Cala the depreciatia shicld earh ynar for this qipment with banus drpreriatian. g. If Marko has a choce between straight-ine. MACRS and bos depreciatian schedules, and itsarginal corp ax raie is experted ta rni onstan, whih schedue shauld it chaose? VWhy? h. How night your aswer lo part () change i Markow anicpatesthat is rmarginal corpcrae tax raie will rncreae substantally ver the next five years? Note: Assurme Ihal the equiprmeput into use in year1 a. et is tha annual depreciation axpanss associated wth this equpmant? The annual drpreciasan expersc is S mi Raund to hrrepacs.)

Answer 1

A	B	C	D	E	F	G	H	I	J	K	L
2		a)
3		Cost of equipment	$18,500,000
4		Expected Life	5	Years
5		Salvage Value	0
6
7		Using straight line depreciation, annual depreciation expense can be calculated as follows:
8
9		Annual depreciation expense	= (Initial cost - Salvage Value)/Expected Life
10			=($18,500,000 - 0)/5
11			$3,700,000.00	=(D3-D5)/D4
12
13		Hence Annual depreciation expense is	$3,700,000
14
15		b)
16		Tax rate	21%
17		Depreciation tax shield is the amount of tax saved due to depreciation expense.
18		It can be calculated as follows:
19
20		Annual Depreciation Tax Shield	=Annual depreciation expense*Tax rate
21			=$3,700,000*21%
22			$777,000	=D13*D16
23
24		Hence Annual Depreciation Tax Shield is	$777,000
25
26		c)
27
28		Depreciation each year can be calculated as follows:
29		Capital cost (B)	$18,500,000
30		Expected Life	5	Years
31		Since Depreciation follows MACRS 5 year convention, therefore
32		the depreciation each year can be calculated as follows:
33				Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
34		MACRS 5 Year depreciation rate (rt)		20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
35		Depreciation Expense(B*rt)		$3,700,000	$5,920,000	$3,552,000	$2,131,200	$2,131,200	$1,065,600	=$D29*J34
36
37		Hence using 5 Year MACRS Convention,
38			Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
39		Depreciation Expense		$3,700,000	$5,920,000	$3,552,000	$2,131,200	$2,131,200	$1,065,600
40
41		d)
42		Tax rate	21%
43		Depreciation tax shield is the amount of tax saved due to depreciation expense.
44		It can be calculated as follows:
45
46		Annual Depreciation Tax Shield	=Annual depreciation expense*Tax rate
47
48		Hence using 5 Year MACRS Convention,
49			Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
50		Depreciation Expense		$3,700,000	$5,920,000	$3,552,000	$2,131,200	$2,131,200	$1,065,600
51		Depreciation Tax shield		$777,000	$1,243,200	$745,920	$447,552	$447,552	$223,776	=J50*$D$42
52
53		Hence depreciation tax shield will be as follows:
54			Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
55		Depreciation Tax shield		$777,000	$1,243,200	$745,920	$447,552	$447,552	$223,776
56

Formula sheet

Cost of equipment Expected Life Salvage Value Years Using straight line depreciation, ann Annual depreciation expense (Initial cost-Salvage ($18,500,000-0)/5 (D3-D5)/D4 getformula(l 12 Hence Annual depreciation expense is 13 -D11 15 Tax rate Depreciation tax shield is the amour It can be calculated as follows: 17 18 19 Annual Depreciation Tax Shield Annual depreciation -$3,700,000*21% -D13 D16 21 getformula(l Hence Annual Depreciation Tax Shield is 24 -D22 25 27 Depreciation each year can be calcu Capital cost (B) Expected Life Since Depreciation follows MACRS 5 the de 29 -D3 Years iation each year can be Ca Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 0.1152 MACRS 5 Year depreciation rate (rt 0.32 0.192 0.1152 0.0576 SD29 E34 SD29 F34 SD29*G34 SD29 H34SD29 I34 SD29J34 getformulal Hence using 5 Year MACRS Conventi Year 1 Year 4 Year 0 Year 2 Year 3 Year 5 Year 6 Expense E35 =G 35 -135 -F35 -H35 135 Tax rate Depreciation tax shield is the amour It can be calculated as follows: 0.21 Annual Depreciation Tax Shield Annual depreciation 47 Hence using 5 Year MACRS Conventi Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 iation Expense E39 H39 -F39 -G39 -139 Depreciation Tax shield 52 Hence depreciation tax shield will b Year 3 -G51 Year 0 Year 4 Year 1 -E51 Year 2 Year 5 Year 6 iation Tax shield -F51 H51 JSI