Problem 9.2:Accelerated Depreciation Tax Advantages The Lecourt Corporation is t

Question

Problem 9.2:Accelerated Depreciation Tax Advantages The Lecourt Corporation is trying to decide whether it should depreciate its new equipment using the straight-line method or double-declining-balance method. The company purchased the equipment on January 1, at a cost of $150,000, with an estimated residual value of $30,000, and a useful life of five years.The company pays its taxes at the end of each year and expects its effective income taxes rate to be 35%. The company expects to be able to invest at an after-tax rate of 4% Calculate the increase in resources the Lecourt Corporation can expect to have at the end of five years by using double-declining-balance depreciation instead of straight-line depreciation Tax Advantage! Cash Available! 4% After-tax to Invest Date DDB Vs SL Return + $4,200.00 $ $ 17,304.00 ? - $7,560.00$ 686.25 Totals$ $2,293.71 $

Explanation / Answer

The increase in resources essentially is the total value of tax savings and any further returns from investing this return.

Under the Straight Line Method, Annual Depreciation would be calculated as:

(Total Cost - Residual Value)/ Useful Life = (150,000 - 30,000)/5 = $24,000

Under the Double Declining method, the depreciation rate would be 1/5years = 20%. The annual depreciation would be calculated as (Opening Net Book Value) X 2 X Double Declining Rate. Tha Annual depreciation would be:

Year 1: $150,000 X20% X 2 = 60,000

Year 2: ($150,000 - 60,000) X 20% X 2 = 36,000

Year 3: ($90,000 - 36,000) X 20% X 2 = 21,600

In Year 4 we would depreciate the remaining 2400(120,000 - 60,000 - 36,000 - 21,600)

Since the asset is already fully depreciated there would be no depreciation charge in year 5 under the double declining balance method.

Based on the above calculation we can compute the increase in resources as follows:

After Tax Return
(4% X D)

A B C D E Depreciation in SL Depreciation in DL Tax Benefit
(B-A)X35% Total Cash Available

After Tax Return
(4% X D)

Year 1                        24,000                        60,000                        12,600                               -                                 -   Year 2                        24,000                        36,000                          4,200                        12,600                        504.00 Year 3                        24,000                        21,600                            -840                        17,304                        692.16 Year 4                        24,000                          2,400                         -7,560                        17,156                        686.25 Year 5                        24,000                               -                           -8,400                        10,282                        411.30

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