You are tasked with comparing the tax savings from two different depreciation me
ID: 2342730 • Letter: Y
Question
You are tasked with comparing the tax savings from two different depreciation methods. You’ve purchased an asset for $100,000. It has a depreciable life of 5 years. The marginal tax rate is $30%. The minimum return on alternative investments is 10%.
If the asset can be depreciated to zero value at the end of 5 years by the “straight line method”, what is the applicable depreciation schedule?
Schedule A
Schedule B
Schedule C
Schedule D
Schedule E
Year 1
$20k
$20k
$100k
$50k
$75k
Year 2
$20k
$30k
$0
$25k
$25k
Year 3
$20k
$25k
$0
$15k
$0
Year 4
$20k
$15k
$0
$10k
$0
Year 5
$20k
$10k
$0
$0k
$0
Which depreciation schedule would contribute the greatest savings if it were used in an NPV calculation for the asset?
Which depreciation schedule would contribute the least savings in an NPV calculation?
If schedule D were used, how much of the asset is left to be depreciated at the end of Year 2? This is called the “book value” of the asset. That value is tracked by the accounting department as the value of the asset (from a tax perspective) that remains on the “books”.
Schedule A
Schedule B
Schedule C
Schedule D
Schedule E
Year 1
$20k
$20k
$100k
$50k
$75k
Year 2
$20k
$30k
$0
$25k
$25k
Year 3
$20k
$25k
$0
$15k
$0
Year 4
$20k
$15k
$0
$10k
$0
Year 5
$20k
$10k
$0
$0k
$0
Explanation / Answer
Cost of asset 100,000 Life 5 Depreciation per year in SLM 1/5 20.00% So Depreciation of 100000*20%= 20K every year So applicable schedule is A Solution 2 Every depreciation schedule will provide annual depreciation which in turn will provide the tax benefit @ 30% so let's calculate the NPV of the tax benefit generated by depreciation Year Schedule A Tax saving-Schedule A Schedule B Tax saving-Schedule B Schedule C Tax saving-Schedule C Schedule D Tax saving-Schedule D Schedule E Tax saving-Schedule E 1 20,000 6,000 20,000 6,000 100,000 30,000 50,000 15,000 75,000 22,500 2 20,000 6,000 30,000 9,000 - 25,000 7,500 25,000 7,500 3 20,000 6,000 25,000 7,500 - 15,000 4,500 - 4 20,000 6,000 15,000 4,500 - 10,000 3,000 - 5 20,000 6,000 10,000 3,000 - - - Now let's calculate the PV of these tax benefits Year Tax saving-Schedule A Tax saving-Schedule B Tax saving-Schedule C Tax saving-Schedule D Tax saving-Schedule E NPV factor @ 10% Tax saving-Schedule A Tax saving-Schedule B Tax saving-Schedule C Tax saving-Schedule D Tax saving-Schedule E 1 6,000 6000 30000 15000 22500 0.909 5,455 5,455 27,273 13,636 20,455 # 2 6,000 9000 0 7500 7500 0.826 4,959 7,438 - 6,198 6,198 # 3 6,000 7500 0 4500 0 0.751 4,508 5,635 - 3,381 - # 4 6,000 4500 0 3000 0 0.683 4,098 3,074 - 2,049 - # 5 6,000 3000 0 0 0 0.621 3,726 1,863 - - - # NPV of tax saving 22,745 23,464 27,273 25,265 26,653 Greatest saving option Schedule C Least saving option Schedule A Solution 3 If schedule D is used Year Schedule D 1 50,000 2 25,000 Total Depreciation charged 75,000 Cost 100,000 Remaining book value 25,000
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