Depreciation Alternatives
Medsupply Inc. produces supplies used in hospitals and nursing homes. Its sales, production, and costs to produce are expected to remain constant over the next five years. The corporate income tax rate is expected to increase over the next three years. The current rate, 15%, is expected to increase to 20% next year, then to 25%, continuing at that rate indefinitely.
Medsupply is considering the purchase of new equipment that is expected to last five years and to cost $150,000 with zero salvage value. As the controller, you are aware that the company can use one method of depreciation for accounting purposes and another method for tax purposes. You are trying to decide between the straight-line and the double-declining-balance methods.
Required
Recommend which method to use for accounting purposes and which to use for tax purposes. Be able to justify your answer on both a numerical and a theoretical basis. How does a noncash adjustment to income, such as depreciation, affect cash flow?
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