4. A piece of equipement is bought for $100,000, has a salvage value of $20,000

Question

4. A piece of equipement is bought for $100,000, has a salvage value of $20,000 in 5 years, and the equipment brings in before-lax revenne of $30,000 per year over the 5 years. (o) (5 pts.) Using double-declining balance, calculate the depreciation allowance (DWo) for the equipment in the first 2 years of depreciation. after-tax cash flow for years 1 and (b) (10 pts.) Calculate the taxable income, income tax, and the 2. Assume an income tax rate of 0.4. (e) (5 pts.) For the depreciation choice in part (a), would you expect the company to have to pay tax on the salvage value when the company sells the equipment? Why or why not?

Explanation / Answer

a) Under double declining method the rate of depreciation as per straight line method is doubled and the depreciation is calculated on the written down value applying the rate that we find out.

Straight line depreciation rate = (1 * 100 ) / 5 = 20%

Therefore double declining rate = 20 * 2 = 40%

For first year depreciation = Cost * double declining rate = $100000 * 40% = $40000

For 2nd year depreciation will be calculated on Book Value (BV)

Book Value = Acquisitio Cost - Accumulated Depreciation = $100000 - $40000 = $60000

Depreciation = Book Value * double declining rate = $60000 * 40% = $24000

b.

16000

(40000 * 40%)

9600

(24000 * 40%)

c. If the actual salvage value of the equipment remains same as $20000 then the company will not have to pay any tax on salvage value because the book value of the asset is also $20000 at the end of 5th year.

Hence there would be no profit no loss to the company and so no tax would be payable.

Particulars Year 1 Amount (in$) Year 2 Amount (in$) Revenue before tax 30000 30000 Less: Tax @ 40% (12000) (12000) After tax revenue 18000 18000 Add: Tax Savings in Depreciation

16000

(40000 * 40%)

9600

(24000 * 40%)

After tax cash flow 34000 27600

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