Suppose BearKat Enterprises is considering a project where they will make Espres

Question

Suppose BearKat Enterprises is considering a project where they will make Espresso coffee makers. They can buy the equipment they need to make the coffee makers for $500,000 plus another $40,000 for training and installation. They will have to increase inventory by $50,000 however, accounts payable will increase $20,000. They think they can sell 7,000 coffee makers a year at a price of $65 each. The estimate variable costs at 40% of revenue. They follow a four yeas MACRS schedule for depreciation with the following depreciation rates:

Year 1: 33%

Year 2: 45%

Year 3: 15%

Year 4: 7%

They believe the equipment has a salvage value of $10,000. BearKat Enterprises has a tax rate of 34%.

What are the depreciation expenses in year 2?

Explanation / Answer

Cost of equipment = $500,000

Training and installation expenses = $40,000

Total cost of the equipment = 500,000 + 40,000

= $540,000

Depreciation rate in year 2 = 45%

Hence, depreciation expense in year 2 = 540,000 x 45%

= $243,000

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