1. Two firms purchase an identical piece of equipment for $2,500 at the beginnin
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1. Two firms purchase an identical piece of equipment for $2,500 at the beginning of year 1. The equipment has an estimated useful life of 4 years and estimated residual value of $100. Firm 1 chooses to depreciate the asset straight-line while Firm 2 uses the double-declining balance method. a. Prepare a depreciation schedule for each of the two firms. Year Be ginning Book Depreciation Ending Book Value Accumulated Value ion Ending Book Value Year Beginning Bo Depreciation Accumulated ciation Value b. Additional information about the two firms is provided in the template below. Complete the template and compare the trend in net profit margins for the two firms over the four years. Assume the tax rate for both firms is 30%.Explanation / Answer
Firm 1 Straight line Depreciation Year Beginning Book value Depreciation Expenses Accumulated Depreciation Ending Book Value 1 $2,500 $600 $600 $1,900 2 $1,900 $600 $1,200 $1,300 3 $1,300 $600 $1,800 $700 4 $700 $600 $2,400 $100 Depreciation Expenses = (Cost - Salvage Value)/ Useful Life Depreciation Expenses = ($2500 - $100)/4 $600 Firm 2 Double Declining balance Year Beginning Book value Depreciation Expenses Accumulated Depreciation Ending Book Value 1 $2,500 $1,250 $1,250 $1,250 2 $1,250 $625 $1,875 $625 3 $625 $312.5 $2,187.5 $312.5 4 $312.5 $212.5 $2,400 $100 Depreciation Expense Double declining Rate = 1/4 x 2 50.00% Double-declining balance = [Double declining depreciation rate × Book value at the beginning of the year] Part b Firm A Straight line Depreciation Year 1 2 3 4 Sales $30,000 $32,000 $34,000 $36,000 Less: COGS $26,500 $28,260 $30,020 $31,780 Less:Depreciation $600 $600 $600 $600 EBIT $2,900 $3,140 $3,380 $3,620 Less:Interest $0 $0 $0 $0 EBT $2,900 $3,140 $3,380 $3,620 Less : Tax @ 30% $870 $942 $1,014 $1,086 Net Income $2,030 $2,198 $2,366 $2,534 Net Profit Margin 6.77% 6.87% 6.96% 7.04% Firm B Double Declining Depreciation Year 1 2 3 4 Sales $30,000 $32,000 $34,000 $36,000 Less: COGS $26,500 $28,260 $30,020 $31,780 Less:Depreciation $1,250 $625 $312.5 $212.5 EBIT $2,250 $3,115 $3,667.5 $4,007.5 Less:Interest $0 $0 $0 $0 EBT $2,250 $3,115 $3,667.5 $4,007.5 Less : Tax @ 30% $675 $934.5 $1,100.25 $1,202.25 Net Income $1,575 $2,180.5 $2,567.25 $2,805.25 Net Profit Margin 5.25% 6.81% 7.55% 7.79% For Year 1 and year 2 Firm A net profit margins are higher than firm B and in year 3 and 4 net profit margins for Firm B is higher than firm A.
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