You just purchased a personal computer for $1600. It is a 5 year asset and the s

Question

You just purchased a personal computer for $1600. It is a 5 year asset and the salavage is s100. Compare the 3 depreciation methods available to you (straight line, sum-of-year-digits and double- declining balance) to determine which method is more advantageous to you in claimning the depreciation of this aseet from your taxes. Given: discount rate of 5% per year. An oil field has about 1,000,000 barells of crude valued at $25/barrel in the ground (i.e., it will be another S10/barrel to extract). The extraction plan of this company is as shown below. Compute the amount of depreciation, they can claim each of the first 4 years of operation. Year Number of Barrels Extracted 200,000 150,000 120,000 100,000

Explanation / Answer

SLM Original Cost of computer   $ 1600 Salvage value        $ 100 Estimated life    5 years Annual Depreciation = Original cost - Salvage value / estimated life                                               ( 1600 - 100 ) / 5 = $ 300 Tax Rate 40% Assumed Annual tax benefit = 300*40% =120 Present value of tax benefit on dep = $ 120 for 5 years dscounted at 5% i.e.4.329 = $ 519.48 Sum of years digit: Sum of years = 1+2+3+4+5 = 15 Depreciation: Year 1 =   Cost - Salvage value / 15 *5 = ( 1600 -100 ) / 15 * 5 = $ 500 Year 2 = ( 1600 -100) / 15 * 4 = $ 400 Year 3= 1600 - 100   /15 *3 = $ 300 Year 4= 1600- 100 /15 * 2 = $ 200 Year 5 = 1600 - 100 / 15 * 1 = $ 100 Present value of tax benefir assumed tax rate @40% Year Depreciation Tax benefit@40% PV FACTOR @5% Present value of tax benefit 1 500 200 0.952 190.4 2 400 160 0.907 145.12 3 300 120 0.864 103.68 4 200 80 0.823 65.84 5 100 40 0.784 31.36 Total Present value of tax benefit 536.4 Double declining method: SLM rate = Annual dep / Innitial cost -Salvage *100 =   300/1500 *100 = 20% Year Beginning BV Annual Depreciation BV at the end Tax benefit @40% PV FACTOR @5% Present value of tax benefit 2*SLM RATe*Beg BV 1 1600 640 960 256 0.952 243.71 2 960 384 576 153.6 0.907 139.32 3 576 230.4 345.6 92.16 0.864 79.63 4 345.6 138.24 207.36 55.296 0.823 45.51 5 207.36 107.36 100 42.944 0.784 33.67 Total Present value of tax benefit on depreciation 541.83 Hence, cleared from above calculations that tax benefit in case of double declining method is maximum.

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