A chemical company that manufactures specialty chemicals is considering building
ID: 2585043 • Letter: A
Question
A chemical company that manufactures specialty chemicals is considering building a multipurpose production facility. This company has estimated that the initial cost investment is RM27,000,000.00. The plant is expected to have a useful life 15 years.
a. Calculate the Annual Cost of Depreciations and the Book Values for each methodology;
Straight line
Sum of year digits, SOYD
Double declining balance, DDB
Modified Accelerated Cost Recovery System, MACRS
b.Which method gives the highest Book Value at Year 5 and Why?
c. Perform after-tax analysis if MACRS depreciation with a 5-year recovery. Income and expenses are estimated at RM3,000,000 and RM600,000, respectively. What is expected IRR, given the income tax rate is 25%.
(with steps please, not just tables and excel)
Explanation / Answer
SOLUTION (a):
(1) Straight line Depreciation:
Annual cost of depreciation = (total cost of investment - salvage value) / useful life = 27000000/15= RM1,800,000
(2) Sum of year digits Depreciation:
Annual cost of depreciation = (Depreciation base * remaining useful life) / sum of the years digits
= (27000000*15) / 120 = RM3,375,000
where,
Depreciation base = total cost - salvage value = 27000000 - 0 = RM27,000,000
Remaining useful life = 15 years
Sum of the years digits = 15(15+1) / 2 = 120
(3) Double Declining Balance Method:
Annual cost of depreciation = 2*straight line depreciation percent*(book value - accumulated depreciation)
= 2*6.66%*(27000000 - 0) = (2*6.66*27000000)/100 = RM3,564,000
where,
straight line depreciation percent = 1/15 = 0.0666 or 6.66%
(d) Modified Accelerated Cost Recovery System:
Annual cost of Depreciation = rate*(total cost of investment - accumulated depreciation)
= 5%*(27000000 - 0) = RM1,350,000
NOTE: Follow the depreciation rate % chart for recovery period.
SOLUTION (b):TOTAL ACCUMULATED DEPRECIATION AT YEAR 5 UNDER DIFFERENT METHODS:
WORKING NOTES:
(1) DEPRECIATION EXPENSE(SL) = 1800000*5 = RM9,000,000
(2) DEPRECIATION EXPENSE(SOYD) =(27000000*15)/120 + (27000000*14)/120 + (27000000*13)/120 + (27000000*12)/120 + (27000000*11)/120 = RM14,625,000
(3) DEPRECIATION EXPENSE(DDB) = 3564000 + [2*6.66*(27000000 - 3564000) / 100] + [2*6.66(23436000 - 3121675) / 100] +[2*6.66*(20314325 - 2705868) / 100] + [2*6.66*(17608457 - 2345447) / 100] = RM13,770,023
(4) DEPRECIATION EXPENSE(MACRS) = 1350000 + 9.5%*(27000000 - 1350000) + 8.55%*(27000000 - 1350000 - 2436750) + 7.7%*(27000000-1350000 - 2436750 - 1984733) + 6.93%*(27000000 - 1350000 - 2436750 - 1984733 - 1634596) = RM8,763,938
BOOK VALUE AFTER CONSIDERING THE DIFFERENT DEPRECIATION METHOD AT 5 YEARS:
The Modified Accelerated Cost Recovery System(MACRS) gives the highest book value at year 5. This is because MACRS follow the depreciation rate % chart considering the recovery period which is more of suitable for the calculation of depreciation expense and thus gives us a higher book value comparing to others.
METHODS DEPRECIATION EXPENSE(RM) 1. STRAIGHT LINE 9,000,000 2. SUM OF YEAR DIGITS 14,625,000 3. DOUBLE DECLINING METHOD 13,770,023 4. MODIFIED ACCELERATED COST RECOVERY SYSTEM 8,763,938Related Questions
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