Q1) The Big Deal Company has purchased new furniture for their offices at a reta

Question

Q1)

The Big Deal Company has purchased new furniture for their offices at a retail price of $100,000. An additional $20,000 has been charged for insurance, shipping and handling. The company expects to use the furniture for 8 years (useful life = 8 years) and then sell it at a salvage (market) value of $10,000. Using the Double Declining Balance method for depreciation , what is the depreciation in the second year?

Q2)

A second hand bulldozer acquired at the beginning of the fiscal year at a cost of $68,000 has an estimated salvage value of $9,500 and an estimated useful life of 12 years. What is the amount of annual depreciation using straight line depreciation?

Q3)

A young woman engineer decides to save towards her retirement fund that pays 8% interest compounded quarterly (the market interest rate). She feels that $600,000 worth of purchasing power in today's dollars will be adequate to see her though her sunset years forty years from now. Assume the inflation rate will be 6%, what should be her quarterly payments in actual dollars?

Explanation / Answer

1. Solution) Computation of depreciation of 2nd year using the Double Declining Balance method:

The double declining balance method of depreciation is also called as the 200% declining balance method of depreciation, that means : double declining balance method = 200% of the straight line depreciation rate.

Here, first we need to calculate the straight line depreciation rate:

straight line depreciation rate = 100% / useful life of the asset = 1 / 8years = 0.125 = 12.5%

Then, Depreciation Rate under double declining method = 2 * 12.5% = 25% per year.

Now let us compute the depreciation:

Depreciation in the second year = 22,500.

2. Solution) Computation of amount of annual depreciation using straight line depreciation:

Depreciation = cost - salvage vale / useful life of the asset

= 68,000 - 9,500 / 12years = 58,500 / 12 = 4,875 is the depreciation under straight line method.

2. Solution) Given interest rate per quarter = 8% / 4 = 2% per quarter and inflation rate = 6%

Actual dollar analysis: here 160 = 40years * 4 quarters = 160 payments
A (F/A, 2%, 160) = $600,000 / (F/P, 6%, 40)

A * 1138.495 = $600,000 / 0.097222

A * 1138.495 = $6,171,431

A = $6,171,431 / 1138.495

A = $5,420.69

Constant dollar analysis:
Given:i = 2% per quarter, Inflation (f) = 6% per year,

we need to find the inflation free interest rate (i) per quarter.

Before computing, we first compute the equivalent inflation rate per quarter.

=> (1 +f) 4 – 1 = 6%

f = 1.4674% per quarter

i = (i -f)/ (i +f)= (0.02 – 0.014674) / (1 + 0.014674) = 0.525% is the interest rate.

Now, we can establish the following equivalence relationship:

A * (F/A, 0.525%, 160) = $600,000

A * 249,749 = $600,000

A = $2,402.41

Note: (F/P, 6%, 40) = 1 / (1+6%)40 = 0.09722

(F/A, 2%, 160) = sum of all i.e, {1 / (1+2%)1 + 1 / (1+2%)2 + 1 / (1+2%)3 + .+.+.+.+.+.+ 1 / (1+2%)160} = 1138.495

Year Begining book value Depreciation % Depreciation expenses Ending book value 1 100,000 + 20,000 = 120,000 25% 30,000 90,000 2 90,000 25% 22,500 67,500

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