(10 pt) (PTW problem 7-11). The initial installed cost for a new piece of equipm
ID: 1190579 • Letter: #
Question
(10 pt) (PTW problem 7-11). The initial installed cost for a new piece of equipment is $10,000. After the equipment has been in use for 4 years, it is sold for $7,000. The company that originally owned the equipment employs a straight-line method for determining depreciation costs. If the company had used the MACRS 5-year method for determining depreciation costs, the asset or book value for the piece of equipment at the end of 4 years would have been $1728. The total income tax rate for the company is 35% of all gross earnings. Capital gains taxes amount to 20% of the gain. How much net savings would the company have achieved by using the MACRS method instead of straight-line depreciation method?
Explanation / Answer
Straight-line depreciation = (Cost of equipment – Scrap value) / Number of years
= (10,000 – 7,000) / 4
= $750
Total depreciation under straight-line method = $750 × 4 = $3,000
Income tax on total straight-line depreciation = $3,000 × 35% = $1,050
MACRS depreciation
Year
Rate
MACRS depreciation
Book value
1
20%
10,000 ×20% = $2,000
8,000
2
32%
10,000 ×32% = $3,200
4,800
3
19.20%
10,000 ×19.20% = $1,920
2,880
4
11.52%
10,000 ×11.52% = $1,152
1,728
5
$8,272
Capital gain tax (under MACRS) = (Scrap value – Book value) × 20% tax rate
= (7,000 – 1,728) × 20%
= 5,272 × 20%
= 1,054.4
Income tax on total MACRS depreciation = $8,272 × 35% = $2,895.2
Net savings = (Income tax (MACRS) – Capital gain tax) – (Income tax straight-line)
= ($2,895.2 - $1,054.4) - $1,050
= $790.8 (Answer)
Year
Rate
MACRS depreciation
Book value
1
20%
10,000 ×20% = $2,000
8,000
2
32%
10,000 ×32% = $3,200
4,800
3
19.20%
10,000 ×19.20% = $1,920
2,880
4
11.52%
10,000 ×11.52% = $1,152
1,728
5
$8,272
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