Lilly Company is planning to buy a set of special tools for its grinding operati

Question

Lilly Company is planning to buy a set of special tools for its grinding operation. The cost of the tools is $18,000. The tools have a three-year life and qualify for the use of the three-year MACRS. The tax rate is 40 percent; the cost of capital is 12 percent. You must use the Exhibit 19B.1 and Exhibit 19B.2 present value tables and Exhibit 19.5 to solve the following problems. Calculate the present value of the tax depreciation shield, assuming that straight-line depreciation with a half-year life is used. Round intermediate calculations and your final answer to the nearest dollar. Calculate the present value of the tax depreciation shield, assuming that MACRS is used. Round intermediate calculations and your final answer to the nearest dollar. What is the benefit to the company of using MACRS?

Explanation / Answer

All calculations are rounded off

cost is 18000/- dollars

1) using straight line method for calculating depreciation:-

cost of capital is 12% and for 3 years cumulative value fotr calculating todays present value of cost is 18000/2.402

(where 2.402=0.893+0.797+0.712) this is present value of 12% for 1st year,2 and 3 year respectively

present value of 18000 for 3 years is 7493/-(rounded off)

depreciaion = cost -scrap value/no of years

=7494/0.5=14988/- dollars

nil = scrap value

Tax depreciation shield= depreciation *(1-tax rate)

=14988(1-.40)

8992/- dollars

2)calculation of dep shield acc to MACRS

cost * present value factor accordig to 12% *MACRS rate for each year

18000*0.893*33.33%=5357

18000*0.797*44.45%=6376

18000*0.712*14.81%=1898

18000*0.635*7.41% =847

total = 14478 =dep

dep shield = 14478*(1-0.40)

8687 dollars

in macrs we calculate for no. of years +1 =(3+1=4 years)

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