4. A company buys some office furniture and fixtures. It spends 40,000. It will

Question

4. A company buys some office furniture and fixtures. It spends 40,000. It will estimate its taxes as an accounting procedure. It will use ordinary (not double) declining balance depreciation to do the depreciation calculation since this is an internal purposes calculation only. The office furniture is dark brown, in a kind of Victorian style. It will be used on the 3 rd floor. The salvage value of the furniture will be 2000 after ten years. Mr Ferdinand will be in charge of the furniture. It will generate AFTER TAX 12,000 in revenue each year for 20 years. The income tax rate will be assumed to be 0.4. Mr Ferdinand's dog name is Fido. Perform the tax effects analysis as discussed in class (and chapter 10 in the text) where you show the BEFORE tax cash flow, depreciation, taxable income, taxes and after-tax cash flow for each year in a table. In the interests of time do only the first five years.

Explanation / Answer

Revenue after tax for each annual year = 12,000

Depreciation rate for ordinary declining base = 1/10 years = 10%

Depreciation for first year = 40,000*10% = 4,000, Similarly depreciation for second year will be calculated at the rate of 10% on reduced depreciable base (i.e.40,000-4,000) = 36,000*10% = 3,600 and so on for all other years

Revenue before tax = 12,000/(1-0.40) = 20,000

This revenue before tax of 20,000 is before tax cash flow for each annual year as no depreciation is deducted from it.   

Tax Effects Analysis   

Years Before tax Cash Flow (1) Depreciation (2) Taxable Income (3 = 1-2) Taxes (4 = 3*0.40) After taxes cash Flow (5 = 1 - 4) 1 20,000 4,000 16,000 6,400 13,600 2 20,000 3,600 16,400 6,560 13,440 3 20,000 3,240 16,760 6,704 13,296 4 20,000 2,916 17,084 6,834 13,166 5 20,000 2,624 17,376 6,950 13,050

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