Question

I want to know why did my professor modify the formula in this problem?

When solving for depreciation, I know the formula is (depreciation = [initial cost - residual value / # of useful years]). However, my professor did this instead: depreciation = initial cost / # of useful years. The problem states that you should find the deprecation using the straight line method. Here is the problem for reference:

Using the operating cash flow information from the previous problem, determine whether Grady Precision Measurement Tools should add the GPS system to its set of products. The initial investment is $1,440,000 for manufacturing equipment, which will be depreciated over six years (straight line) and will be sold at the end of five years for $380,000. The cost of capital is 10%, and the tax rate is still 35%.

His solution:

Find the after-tax cash flow at disposal of the equipment:
Book Value (Basis at end of five years)
Original Cost $1,440,000
Depreciation expense per year is $1,440,000 / 6 = $240,000 <---- part I don't understand
Accumulated depreciation is 5 × $240,000 = $1,200,000
Basis = $1,440,000 – $1,200,000 = $240,000
Gain on Disposal = $380,000 – $240,000 = $140,000
Tax on Disposal = $140,000 × 0.35 = $49,000

Answer 1

In questions like these where it is written "will be depreciated over six years (straight line) and will be sold at the end of five years for $380,000", we depreciate to zero i.e., we use the formula depreciation = initial cost / # of useful years

But where it written "will be depreciated over six years (straight line) to residual value of $380,000", we depreciate to 380000, i.e., we use the formula depreciation = [initial cost - residual value / # of useful years]..That is residual value word will be mentioned.