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The straight-line (SL) method is often used for intangible property. For example, Veronica's firm bougl-n a patent in Apdl
that was not acquired as part of purchasing a business . She paid $6800 for this patent and must use the straight-line
method to depreciate it over 17 years with no salvage value. The annual depredation is $400 (= $6800/17). Since the
patent was purchased in April, the first year 's deduction must be prorated over the 9 months of ownership. This year the
deduction is $300 (= $400 x 9/12), and then next year she can begin taking the full $400 per year.

Declining Balance Depreciation

Declining balance depredation applies a constant depmciation race to the property's declining book value. For longer
life assets a rate of 150% may be used, but the most common rate is 2.00% of the straight-line rate. Since 200% is tw"ice
the straight-line rate., it is caHed double dedming balance, or DOB; the general equation is

2 (11 -3a)
Double declining balance d, = N(Book value,_,)

Since book value equaJs cost minus depredation charges to date,

DDB dr = ~
1
Cost - Depreciation chai-ge to date)

or

(11 -3b)
2 ( I- )
d, = N ' B - ~ dj
J= l

EXAMPLE 11-3
Compute the DOB depreciation schedule for the situation in Example 11-2 ($1000):
Cost of the asset, B $900
Depreciable life, in years, N 5
Salvage value, S $70

SOLUTION

Depredation for Year t Sum of Depreciation Book Value

Using Equ tion 11"'4a Charges Up to Year t at End of Ye rt
Yea,r ($1000) ($1000} ( $1000)
I l
t d, E dj BVi=B- E dJ
j=I j =i
1 (2/ 5 900 = 360 $360 900 - 60 = 540
2. (2/ 5 540 = 216 576 900 - 576 = 324
3 (2/ 5 324 = 130 706 900 - 706 = 194
4 (2/ 5 194 = 78 784 900 - 784 = 116
5 (2/ 5 116 = 46 830 900 - 830 = 70 = S

Figure 11-5 illustrates the situation.

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Declining B11lnm,c
B Dc-pn:cietioo Charges
S900
360
&
8 540
;;;
"
:,
j 334
-"'
B
lil:i 194
116
70
s
0 2 3 4 5
= N (years
Time, Dq,moiablc Life

FIG RE 11-5 Declining balance depreciation.

The final salvage value of $70,000 for Examples 11-2 and 11-3 was chosen to match the ending value for the double
declining balance method. This does not nonnally happen. If the final salvage value of Example 11-3 had not been
$70,000, the double declining balance method would have had to be modified . One modification stops further
depreciation once the book value has come to equa] the salvage value-this prevents taking too much depredation. The
other modification would switch declining balance depreciation to straight line-this ensures taking enough depreciation.

DEPRECIATJO,N FOR TAXES-BONUS DEPRECIATION

Bonus depreciation in the U.S. became available for the 2001 tax year. When available, it aUows the expensing or
immediate write-off of a specified percentage of an asset's cost basis. This percentage may be as high as 100% . From the
firm's perspective, using the largest bonus depreciation allowed means the PW of tax savings is maximized. This is very
attractive . When bonus depredation is less than 100%, the remaining book value is depreciated with other methods.
From the government's perspective, bonus depreciation stimulates business activity and investment, and thus the
economy. Figure H-6 il1ustrates that the bonus percentage rate has fluctuated over time. When first introduced, bonus
depreciation was viewed as a temporary special case. It appears that it has become a permanent pa11 of our tax code.

Tax Cuts & Jobs Act

The Tax Cuts & Jobs Act (TCJA), approved in December 2017, made significant changes to mies governing asset
depreciation for taxes. In particular, the TCJA expanded bonus depreciation. Specifically, the rate through 2022 was
increased to 100% (from pJanned declines to 40%, 30%, and 0% in 2018, 2019, and 2020). When 100% bonus
depreciation is used, boo k value becomes zero, and recaptured depreciation occurs if th e asset is sold.
Under the TCJA. 100% bonus depreciation is available from 2018 to 2022; then it is scheduled to begin a 5-year
phase-out. As shown in Figure 11-6, in 2023, bonus depreciation will apply to 80% of an asset's value. In each folJowing
year, bonus depreciation will apply to 60%, then 40%, then 20%, and finally 0% of an asset's value. The ponion of an
asset's value not subject to bonus depreciation uses MACRS .
Bonus Dq,moialion Ra1e

100% : ---- -~--

I
... ..·:· ..
.
a" . .......--~-.i
I
~ SO% I .
15 I
I
.
;
"ii 60% ········•·•···
·o I
" I

...,e-
.,
40% •
.............
. I
. I
1l
C 20%
i I
····-~---
:
. ••I
.::0

0%
.
I

2000 2005 20IO 2015

Year

- Actlllal ••••• Planned

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FIG RE 11-6 Historical and planned bonus depreciation rates.

For the first time, TCJA also allowed bonus depreciation to be applied to used assets purchased and put into service by
a new owner. Bonus depreciation is not available in electrical energy, water, sewage disposal, and gas or steam
distribution utilities. Tangible property with recovery pedods over 20 years and passenger vehicles do not quaJify for
bonus depreciation. In addition, a number of states have disallowed bonus depreciation for compuHng state taxes.
The Tax Cuts and Jobs Act also expanded the Section 179 deduction for small businesses. The Act allows complete
expensing of up to $1 million of capital expenditures in the year of purchase. While this is more limited than the current
100% bonus depreciation, for eligible businesses it has allowed immediate expensing of capital costs every year since
1987 with a maximum expensing limit that has been steadily increasing.

EXAMPLE 11-4
A persona] property asset has a cost basis of $80,000 and an expected salvage of $20,000. It is not subject to special
limitations for bonus depreciation. How much bonus depreciation was, is, or will be allowed
(a) in 2015?
(b) in 2019?
(c) in 2023?
(d) in 2027?

SOLUTION
Bonus depreciation is calculated on the cost basis. The salvage value is patt of the recapture/loss calculations when the
asset is disposed of.
(a) $40,000 = 50% X $80,000
(b) $80,000 = 100% x $80,000
(c) $64,000 = 80% X $80,000
(d) $0 = 0% x $80,000

EXAMPLE 11-5 (Examples 11- 2 and 11- 3 revisited)

Dete1mine the depreciation schedule with 100% bonus depreciation for the situations in Examples 11-2 and 11-3 (in
$1000):
Cost of the asset, B $900
Depreciable life, in yeaFS, n 5
Salvage value, S $70

SOLUTION

Depreciation, year 1 $900

Depreciation, years 2-5 0

The asset is 100% depreciated in its first year of use. Any salvage value that occurs after year 1 is taxed as
recaptured depreciation or regular income.

EXAMPLE 11-'6
Consider an asset with a cost basis of $10,000 that has been depreciated using 100% bonus depreciation. What is the
gain or loss if the asset is disposed of after 5 years of operation for (a) $7000, (b) $0, and (c) a cost of 2000?

SOLUTION

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To find gain or loss at disposal we compare market and book value. Since 100% bonus depreciation fully depreciates
an asset dming its first year, the book value equals $0.
(a) Recaptured depreciation= $7000.
(b) Since book value equals salvage value, there is no recaptured depreciation or Joss.
(r) Since the money is paid for disposal, this is less than the book value, and there is a Joss of $2000.
This general method for calculating recaptured depreciation or Joss applies to alJ of the depreciation methods
desCJibed in this chapter.

Because 100% bonus depreciation treats capital investments as expenses, after-tax analysis may no Jonger be needed
for prospective decision making. As wiU be shown in Chapter 12, the before-tax and after-tax rates of return are the same.
Depreciation and tax dete rmination are only required for present or annual worth calculations.

DEPRECIATIO,N FOR TAXES- MACRS DEPRECIATION

The modified accelerated cost recovery system (MACRS) depreciation method. introduced by the Tax Reform Act of
1986, is still the most consistently and broadly allowed method to compute depreciation for U.S. income taxes. Three
major advantages of MACRS are that (1) the "property class lives" are less than the "actual useful lives," (2) salvage
values are assumed to be zero, and (3) tables of annual percentages simplify computations. Use of CRS focuses on the
general depreciation system (GDS), which is based on declining balance with switch to straight-Hoe depreciation. Since
NIACRS assumes 5 = 0 for its annual calculations, MACRS often has recaptured depreciation at disposal.

Property Class and Recovery Period

Each depreciated asset is placed in a MACRS property class, which defines the rerovery period and the depreciation
percentage for each year. The recovery period language was carefu1ly chosen. because those periods are shorter than the
asset's expected life. There are also two property classes for real estate, but those are usually not used by engineers.
The MACRS GDS propetty dasses are described in Table 11-1. The proper MACRS property class can be found
several different ways and are available from the Internal Revenue Service (IRS). Of the three approaches listed, the first
one that works should be used.
1. Property dass given in the problem.
2. Asset is named in Table 11-1 under a prope1ry class.
3. Depreciate as 7-year property for "all other property not assigned to another class."

Tobie 11-1 MACRS GDS Property Classes

Prop-erty Class Personal Property (a11 property exc-ept real estate),
Special hand.ling devices for food and beverage manufacture.
3-year property
Special tools for the manufacture of finished plastic products, fabricated metal products, and motor vehicles
Automobiles and trucks
Aircraft (of non-air-transport companies)
5-year property Equ.ipment used in research and experimentation
Computers
Petroleum drilling equipment
All other property not assigned to another class
?-year property
Office fumi tu11e, flxtures, and equipment
Assets used in petroleum refining and certain food products
10-year property
Vessels and water transportati.on equipment
TeJephone distribution plants
15-year property
unicipal sewage treatment plants
20-year property 1unicipal sewers
For more detail, see Tables B l & B2 in lRS Publication 946, How to Depreciate Property (wv.•w.irs.gov).

Once the ACRS property class is known the year-to-year depreciation deductions can be calculated for assets over
their recovery period using
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UICll 11:\..UVClJ p cuuu u ;:u1 1t5,

d, = B x r1 (11-4)

where dt = depreciation deduction in year r

B = cost basis being depreciated
rt = appropriate MACRS percentage rate

Percentage Tables
The [RS has prepared rnb]es to assist in calculating depreciation charges when MACRS depreciation is used. Table 11-2
gives the yearly depreciation percentages (r~) that are used for the six personal propetty classes (3-, 5-, 7-, 10-, 15-, and
20-year pmpet1y classes). otice that the values are given in percentages-thus, for example, the value of 33.33% (given
in Table 11-2 for Year 1 for a 3-year MACRS propetty) is 0.3333.
Thl!Jle- 11-2 MACRS Depreciation for PersonaJ Property: Half-Year Convention
Applicable Percentage- for Property Class
Recovery 3-Year 5-Year 7-Year HJc-Ye-ar 15,-Ye-ar 20~Ye-ar
Year Property Pr,operty Pl"operty Pr,operty Property Pr,operty
l 33.33 20.00 14.29 10.00 5.00 3.750
2 44.45 32.00 24.49 18.00 9.50 7.219
3 14.8P' 19.20 17.49 14.40 8.55 6.677
4 7.41 11.52"' 12.49 11.52 7.70 6. 177
5 11.52 8.93* 9.22 6.93 5.713
6 5.76 8.92 7.37 6.23 5.285
7 8.93 6.55"' 5.90* 4.888
8 4.46 6.55 5.90 4.522
9 6.56 5.91 4.462*
10 6.55 5.90 4.461
11 3.28 5.91 4.462
12 5.90 4.461
13 5.91 4.462
14 5.90 4.461
15 5.91 4.462
16 2.95 4.461
17 4.462
18 4.461
19 4.462
20 4.461
21 2.231

Computation method

• The 3-, 5-, 7-, and 10-year classes use 200% and the 15- and 20-year classes use 150% declining balance
depreciation.
• All classes convett to straight-line depreciation in the optimal year, shown with asterisk("') .
• A half-year of depreciation is allowed in the first an d last recovery years.
Notice in Table 11-2 that the depreciation percentages continue for one year beyond the property class life. For
example, a MACRS 10-year property has an rt value of 3.28% in Year 11. This is due to the half-year convention that also
halves the percentage for the first year. The half-year convention assumes that a11 assets are placed in service at the
midpoint of the first year.
Another characteristic of the MACRS percentage tables is that the rt values in any column sum to 100%. This means
that assets depreciated using MACRS are fully depreciated at the end of the recovery period. This assumes a salvage
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I .; , .
value of zero.

Calcullating and Using MACRS Percentage· Rates (rr)

NIACRS is based on declining balance with a switch to straight line. That combined method is used with three frnther
assumptions that are detailed at the boaom of Table 11-2.
As shown in Example 11-7, the MACRS percentage rates can be derived from the declining balance and straight-line
methods. However, it is obviously much easier to simply use the rt values from Table 11-2..

EXAMPLE 11-7
Consider a 5-year ACRS property asset with an instaJled and "made ready for use" cost basis of 100. (Note: The
$100 value used here is for illustration purposes in developing the rates. One would not depreciate an asset with a cost
basis of only $100.) Develop the MACRS percentage rates (rt) for the asset based on the underlying depreciation
methods.

SOLUTION
To develop the 5-year MACRS property percentage rates, we use the 2.00% declining balance method, switching over
ro straight line at the optimal point. Since the assumed salvage value is zero, the entire cost basis of $100 is
depreciated. Also the $100 basis mimics the 100% that is used in Table 11-2.
Let's explain the accompanying table year by year. In Year 1 the basis is $100 - 0, and the dt values are halved for
the initial half-year assumption . Double declining balance has a rate of 40% for 5 years (= 2/5). This is larger than
straight line for Year 1. So one-ha1f of the 40% is used for Year 1. The rest of the declining balance computations are
simply 40% x(basis minus the cumulative depreciation).
In Year 2 there are 4.5 years remaining for straight line, so 4.5 is the denominator for dividing the remaining 80 in
book value. Similarly in Year 3 there are 3.5 years remaining. In Year 4 the DDB and SL calculations happen to be
identical, so the switch from DDB to SL can be done in either Year 4 or Year 5. Once we know that the SL depredation
is 11.52 at the switch point, then the only further calculation is to halve that for the last year.
Notice that the DOB calculations get smaller every year, so that at some point the straight-line calculations lead to
faster depreciation. This point is the optima] switch point, and it is built into Table 11-2 for MACRs.
Year DDB CaJculation SL Calculation MACRS rt(%) Rates Cumulative De~reciation (%)
1 (1/2)(2/5)(100 - 0) =20.00 1/2(100 - 0}/5 =10.CIO 20.00(DDB) 20.00
2 (2/5)(100 - 20.00) =32.00 (100 - 20)/4.5 = 17.78 32.00(DDB) 52.00
3 (2/5)(100 - 52.00) =19.20 (100 - 52)/3.5 = 13.71 19.20(DDB) 71.20
4 (2/5)(100 - 71.20) =11.52 (100 - 71.20)/2.5 =U.52 11.52 (either) 82.72
5 11.52 11.52 (SL) 94.24
6 (1/2) (11.52) = 5. 76 5.76 (SL) 100.00
The values given in this example match the rt percentage rates given in Table 11-2 for a 5-year MACRS property.

EXAMPLE 11-8
Use the MACRS to calculate the yearly depreciation allowances and book values for a film that has purchased
$150,000 worth of office equipment that does not qualify for 100% bonus depreciation. The equipment is estimated to
have a salvage (market) value of $30,000 (20% of the original cost) after 10 years.

SOLUTION
1. The assets qualify as depreciable propetty.
2. The cost basis is given as $150,000.
3. The assets are being placed in service in Year 1 of our analysis.
4. MACRS applies.

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5. The salvage value is not used with MACRS to calculate depreciation or book value.
Office equipment is listed in Table 11- 1 as a 7-year propetty. We now use the MACRS 7-year property percentages
from Table 11- 2 and Equation 11-4 to calculate the year-to-year depreciation allowances. We use Equation 11-1 to
calculate the book value of the asset.
Year, t MACRS, .r t Cost Basis dt Cumulative d 1 BV t = B - Cum.d t
1 14.29% X $150,QQQ $21,435 $21,435 $128,.565
2 24.49 150,000 36,735 58,170 91,830
3 17.49 150,000 26,235 84,405 65,595
4 12.49 150,000 18,735 103,140 46,860
5 8.93 150,000 13,395 116,535 33,465
6 8.92 150,000 13,380 129,915 20,085
7 8.93 150,000 13,395 143,310 6,690
8 4.46 150,000 6,690 150,000 0
100.00% $150,000
10 -$30,000 recaptured depredation
Notice in this example several aspects of the MAC RS depreciation method: (1) the sum of the r 1 values is 100.00%,
(2) this 7-year MACRS property is depreciated over 8 years(= property class life + 1), (3) the book value after 8 years
is $0, and (4) the salvage value is recaptured depreciation in year 10.

If the asset is in the middle of Its depreciable life, then recaptured depreciation and losses are calculated in a similar
manner-compare the market and book values at the time of disposal. However, in computing the book value with
MACRS depreciation, a special rule must be applied for assets disposed of before the end of the recovery period. The m]e
is to take one half of the allowable depreciation deduction for that year. This rule assumes that disposals take place on
average halfway th.rough the year. Thus for a 5-year asset disposed of in the middJe of Year 4, the rate allowed for
NtACRS depreciation is half of 11.52% or 5. 76%. If the asset is disposed of in Year 6, it is already past the recovery
period, and a half-year assumption has already been built into the MACRS schedule. Thus, the full r6 is taken.
However, Examp]e 11- 11 iUustrates that economic analyses wil1 arrive at the same taxab]e income whether 0%, 50%,
or 100% of the nonnal depreciation is claimed in the year of disposal.
Thus, correct economic analyses can assume the year of disposal is just like evety other year and claim 100% of that
year 's depreciation.

EXAMPLE 11-9
Consider a $10,000 asset that does not qualify for bonus depreciation. Using MACRS and a 3-year recovery period,
calculate the effect of disposal if this asset is sold during Year 2 for $5000 and
1. 50% depreciation is claimed in Year 2.
2. 0% depreciation is claimed in Year 2.
3. 100% depreciation is claimed in Year 2.

SOLUTION
The first effect of the disposal is a before-tax cash flow of $5000. This is not affected by the amount of depreciation
claimed. The second effect of the disposal is the total deduction from taxable income for that year.
In every case

M½ = 5000 market value in year 2

BV1 = 10.000 - lO.()OOr1
= J0,000 - 10,000 X 0.3333
= 6667

1. If 50% depreciation is claimed in year 2:

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D2 = 10,000(ri/ 2) = to 000 0.4445 / 2 ,

= $2222.50
BV2 = BV1 - D = 6667 - 2222.50
= $4444.50
This is less than MV2 , so excess depreciation must be recaptured.

Recaptured depreciation = 5000 - 4444.50 = 555.50

Total deduction from taxable income = D2 - Recaptured depreciation
= 2_,:22.50 - 555.50 = $1667

2. If 0% depreciation is claimed in year 2: o depreciation, but total deduction from taxable income is the loss
because the market value of $5000 is $1667 ]ess than the book values of $6667.
3. If 100% depreciation is claimed in year 2:

D2 = 10,000 1"2. = 10.000 x 0.4445 = $4450

BV2 = BV1 - D2 = 6667 - 4450 = 2217 < MV2 => depredation recapture
Recaptured depreciation = 5000 - 2217 = 2783
Total deduction from taxable income = D2 - recapture
= 4450 - 2783 = $1667

In all three cases, the total deduction from taxable income is $1667. The first approach follows the tax language. The
second, with 0% claimed, is the easiest for hand calcuiations. The third approach with 100% claimed is the easiest for
spreadsheet calrnlations, because it treats the year of disposal like any other year.

DEPRECIATION FOR TAXES- BONUS PLUS MACRS

When bonus depreciation is less than 100%, or for assets for which only partial bonus depredation is allowed., the rest of
the cost basis must be depreciated by another method. That is done with MACRS, as demonstrated in the following
examples.

EXAMPLE 11-10
An organic foods company engaged in the faml-to-table market purchased $1,300,000 of new 7-year MACRS
equipment. This equipment and firm meet the requirements for full Section 179 and 60% bonus depredation
deductions. What is the total deduction from taxable income for the first year?

SOLUTION
Deductions from taxable income in year 1:
• Section 179: The film claims the $1,000,000 limit, which reduces the equipment's cost basis to $300,000 (=
$1,300,000 - $1,000,000).
• Bonus depreciation: At a 60% rate, an additional $180,000 (= $300,000 x 0.60) is claimed, which fowers the
equipment's cost basis to $120,000 (= $300,000 - $180,000).
• MACRS depreciation: For 7-year NIACRS equipment, the first-year deduction is $17,148 (= $120,000 x
0. 1429). The remaining years of MACRS depreciation wiU use a cost basis of $120,000.
The mtal deduction from taxable income in year 1 is $1,197,148 (= $1,000,000 + $180,000 + 17,148).

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EXAMPLE 11-11 (Examples 11- 2, 11- 3, and 11-5 l'evisited)

Determine the depreciation schedule with 60% bonus depreciation for the situations in Examples 11-2, 11- 3, and 11-5
(in $1000):
Cost of the asset, B $900
Depreciable life, in years, N A:CRS 5-year class
Salvage value, S $70

SOLUTION
Whh 60% bonus depreciation, 0.6 x 900,000 = $540,000 is immediately depreciated (expensed). This leaves 40% of
the asset value ($360,000) as the cost basis to be depreciated using MACRS.
Year, t MACRS,rt Cost Basis dt C111m111lative d t BV t = B - Cum.d t
1 20.00% X $360,000 $72,000 $72,000 $288,000
2 32.00 360,000 115,200 187,200 172,800
3 19.20 360,000 69,120 256,320 103,680
4 11.52 360,000 41,472 297,792 62,208
5 11.52 360,000 41,472 339,264 20,736
6 5.76 360,000 20,736 360,000 0
100.00% $360,000
The total first-year depreciation is $612,000 (= 540,000 + 72,000), leaving a book value of $288,000. The total
second-year depreciation is $115,200, the MACRS depreciation only. At the end of six years, the book va1ue is zero. If
the asset is sold at any time, then depreciation recapture and perhaps capital gains applies.

EXAMPLE l l -12 (Example 11- 8 revisited)

Detennine the depreciation schedule for the prnhlem in Example 11- 8 with 40% bonus depreciation.
Cost of the asset, B $150,000
Depreciable life, in years, N MACRS 7-year class

SOLUTION
Whh 40% bonus depreciation, 0.4 x 150,000 = $60,000 is immedfately depreciated (expensed). This leaves 60% of the
asset value ($90,000) as the cost basis to be depreciated using MACRS.
Year, t MACRS., .r t Cost Basis dt Cumulative d t BV t = B-Cum.d t
1 14.29% X $90,000 $12,861 $12,861 $77,139
2 24.49 90,000 22,041 34,902 55,098
3 17.49 90,000 15,741 50,643 39,357
4 12.49 90,000 ll,241 61,1384 28,116
5 8.93 90,000 8,037 69,921 20,079
6 8.92 90,000 8,028 77,949 12,051
7 8.93 90,000 8,037 85,986 4,014
8 4.46 90,000 4,014 90,000 0
100.00% $90,000
The total first year depreciation is $72,861 (= 60,000 + 12,861), leaving a hook value of $77,139 at the end of the
first year. The second-year depreciation is $2.2.,041, the ;MACRS depreciation.

COMPARING DEPRECIATION METHODS

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In Examples 11- 2., 11-3, and 11- 5 we used the straight-line, declining balance and bonus depre dation methods to
illustrate how the book vafoe of an asset that cost $900,000 and had a salvage value of $70,000 changed over its 5-year
depreciation life. Figures 11- 2 through 11-4 provided a graphical view of book value over the 5-year depreciation period
using these methods. Example 11- 13 compares straight-line, double-declining, MACRS, and bonus plus MACRS
depreciation methods.

EXAMPLE l l-13 (Examples 11-8 and 11-12 revisited)

Consider the equipment that was purchased in Examples 11-8 and 11- 12. Calculate the asset's depreciation
deductions, book values, and present worth of the deductions. Do this for 100% bonus, straight-line, double~declining,
MACRS, and 40% bonus plus MACRS depredation methods.

SOLUTION
Depreciation deductions benefit a firm after taxes because they reduce taxable income and taxes. The time value of
money ensures that it is better to take these deductions as soon as possible. Because 100% bonus depre dation is the
fastest it has the highest PW. In year 1 there is depreciation of $150,000 and in year 10 there is recaptured depreciation
of $30,000. PW= 150,000/l.1 1-30,000/1.1 10 = $124,797.
Tobie 11-3 Comparison of MACRS, Bonus Depreciation, and Classic Methods for Asset in Example 11- 7
Year, t Straight Line Double Declining MACRS 40 % Bon11s Depreciation Pl11s MACRS
dt BV1 dt BVt dt BVt d1 BV1
1 12,000 138,000 30,000 120,000 21,435 128,565 72,861 77,139
2 12,000 126,000 24,000 96,000 36,735 91,830 22,041 55,098
3 12,000 114,000 19,200 76,800 2:6,235 -65,595 15,241 39,357
4 12,000 102,000 15,360 61,440 18,735 46,860 11,241 28,116
5 12,000 90,000 12,288 49,152 13,395 33,465 8,037 20,079
6 12,000 78,000 9,830 39,322 13,380 20,085 8,028 12,051
7 12,000 66,000 7,864 31,457 13,395 6,690 8,037 4,014
8 12,000 54,000 1,457 30,000 6,690 0 4,014 0
9 12,000 42,000 0 30,000 0 0 0 0
10 12,000 30,000 0 30,000 0 0 0 0
Recaptured depr. 0 0 -30,000 -30,000
PW10% $62,169 $78,351 $96,651 $107,910

$[50,000
I ·-.. _
I
[25,000 \
I
I
.,
:::,
1.00,000 I
\
I
~ 75,000 I
u I
I
:I:i \
50,000 I
I
I
1
25,000 I '·•·-._
I
I
.....
0 1 4 6 8 10
Ye.Mt

FIG RE 11-7 Compating straight line ( ), double dedining balance(- - - -), MACRS (
..............), and 100% bonus depreciation (-- ___ .).

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When computing cash flows and income taxes, the 100% bonus depreciation schedule results in the highest PW and
thus it will minimize the PW of taxes. However, for va]uing the business the straight-line deductions have the lowest PW,
thus maximizing the firm's repmted value.

UNIT-OF-PRODUCTION DEPRECIATION
At times the recovery of depreciation on a particular asset is more closely related to use than to time. In these few
situations (and they are rare), the unit-of-production (UOP) depredation in any year is

Production for year (11-5)

UOP depreciation in any year = (B - S)
Total li fetime production for as et

This method might be useful for machinery that processes natural resources if the resources will be exhausted before
the machinery wears out. Histotically, this method was sometimes used for construction equipment that had very heavy
use in some years and very light use in others. It is not considered an acceptable method for general use in depreciating
industrial equipment.

EXAMPLE 11-14
For nurnelical similarity with previous examples, assume that equipment costing $900,000 has been purchased for use
in a sand and gravel pit. The pit wilJ operate for 5 years, while a nearby airpmt is being reconstmcted and paved. Then
the pit will be shut down, and the equipment removed and sold for $70,000. Compute the unit-of-production (UOP)
depreciation schedule if the airpmt reconstruction schedule calls for 40,000 m3 of sand and gravel as follows:
Year Rl!i)uir,ed Sand and Gravel (m3 )
1 4,000
2 8,000
3 16,000
4 8,000
5 4,000

SOLUTION
The cost basis., B, is $900,000. The salvage value, S, is $70,000. The total lifetime production for the asset is 40,000 m3
of sand and gravel. From the airport reconstruction schedule, the first-year UOP depreciation would be

4000 m3
First-year UOP depreciation = 40 000 m3 900,000 - 70,000 = $83,000

Similar cakuJations for the subsequent 4 years give the complete depreciation schedule:

Year UOP Depredation (in $1000)

1 $83
2 166
3 332
4 166
5 83
$830

It should be noted that the actual unit-of-production depreciation charge in any year is based on the actual
production for the year rather than the scheduled production.

DEPLETION
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.Ut:.CLL .I. .I.UPI

Depletion is the exhaustion of natural resources as a result of their removal. Since depletion covers such things as mineral
prope1ties, oil and gas wells, and standing timber, removal may take the form of digging up metallic or nonmetallic
m1nerals, producing petroleum or natural gas from wells, or cutting down trees.
Depletion is recognized for income tax purposes for the same reason depreciation is-capital investment is being
consumed or used up. Thus a pmtion of the gross income should be considered to be a return of the capital investment.
The calculation of the depletion aJlowance is different from depreciation because there are tiNo distinct methods of
calculating depletion: cost depletion and percentage depletion . Except for standing timber and most oil and gas wells,
depletion is calculated by both methods and the larger value is taken as depletion for the year. For standing timber and
most oiJ and gas wells, only cost depletion is permissible.

Cost Depletion
Depreciation relied on an asset's cost, depreciable life, and salvage value to appmtion the cost minus salvage value over
the depreciable life. In some cases, where the asset is used at fluctuating rates, we might use the unit-of-production (UOP)
method of depreciation. For mines, oil wells, and standing timber, fluctuating production rates are the usual situation.
Thus, rnst depletion is computed like unit-of-production depreciation using:
1. Property cost, less cost for Jand.
2. Estimated number of recoverable units (tons of ore, cubic meters of gravel. barrels of oil, million cubic feet of
natural gas, thousand board-feet of timber, etc.).
3. Salvage value, if any, of the property.

EXAMPLE 11-15
A small lumber company bought a tract of timber for $35,000, of which $5000 was the land's value and $30,000 was
the value of the estimated 1.5 million board-feet of standing limber. The first year, the company cut 100,000 board-feet
of standing timber. What was the year's depletion allowance?

SOLUTION

$35,000 - $5000
Depletion allowance p r 1000 board-ft = -------
1500 x 1000 board-ft
= $20 per 1000 board-ft
The depletion allowance for the year would be
100 000 board-ft x $20 p r 1000 board.-ft = 2000

Pen:entage Depletion
Percentage depletion is an alternate method for mineral property. The aUowance is a certain percentage of the property's
gross income dmi ng the year. This is an entirely different concept from depreciation. Unlike depreciation, which allocates
cost over useful life, the pel"centage depletion allowance (see Table 11-4) is based on the property's g;ross income.

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Tobie 11-4 Percentage Depletion AUowances for Selected Deposits

De(Josits Rate
Sulfur, uranium, a:11d, if from deposits i.n the U.S ., asbestos, 1.ead ore, zjnc ore, nickel ore, and mica 22%
Gold, silve.r, copper~ i.ron o~e, and certain oiJ shale, if from deposits in the U.S. 15%
Borax, granjte, limestone, ma.rble, moUusk shells, potash, slate, soapstone, and carbon dioxJde produced from a well 14%
Coal, lignjte, and sodium chloride 10%
Clay and shale used or sold for use in making sewer pipe or bricks or used or sold fo r use as sintered or burned Ughtweight
7 lh~ ,
aggregates
Clay used or sold for use in making drainage and roofing ti.le, flower pots,. and kindred products, and gravel, sand, and stone
5%
(other than stone us.ed or sold for use by a mine owner or operator as dimension or ornamental stone)
Source: lnterna.1 Revenue Service, Publ.ication 535, Chapter 9. Section 613(b) of the lntema.1 Revenue Code gives a complete list of minerals and thei r
percentage depletion rates.

Since percentage depletion is computed on the income rather than the prope1ty's cost, the total depletion may exceed
the cost of the property. In computing the allowable percentage depletion on a property in any year, the percentage
depletion allowance cannot exceed 50% of the prope1ty's taxable income computed without the depletion deduction. The
percentage depletion calculatilons are illustrated hy Example 11- 16.

EXAMPLE 11- t ,6
A coal mine has a gross income of $250,000. Mining expenses equal $210,000 . Compute the allowable percentage
depletion deduction.

SOLUTION
From Table 11--4, coal has a 10% depletion allowance based on gross mining income. The allowable percentage
depletion deduction is also limited to a maximum of 50% of taxable Income.

Computed Percentage Depletion

Gmss income from mfoe $250,000
Dep]etion percentage X 10%
Computed percentage depletion $25,000

Taxable Income Limitation

Gross income from mfoe $250,000
Less: Expenses other than depletion -210,000
Taxable income from mine 40,000
Deduction limitation x50%
Taxable income limhation $20,000

Since the taxable income limitation ($20,000) is less than the computed percentage depletion ($25,000), the
allowable percentage depletion deduction is $20,000. If the cost depletion were higher, it could be claimed instead.

As previously stated, on mineral property the depletion deduction can be based on either cost or percentage depletion.
Each year, depletion JS computed by cost and percentage depletion methods, and the allowable depletion deduction is
the larger of the t\\ro amounts.

SPREADSHEET FUNCTIONS FOR DEPRECIATION

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The spreadsheet functions for depreciation are summarized in Table 11- 5. These functions find the value of the
depreciation in year t. They include parameters fo r cost (initial book value), salvage (final salvage value), and life
(depreciation petiod). Uthe depreciation amounts change, a period (year) must be specified. DDB and VDB include a
factor which has a default value of 2 for 200% or double declining balance, but another commonly used value is 1.5 for
150%. The more complicated final VDB function returns MACRS depreciation amounts for the class life.

Tobie 11-5 Spreadsheet Functions for Depreciation

Depreciation Technique Excel
Straight Une SLN{cost, salvage, life)
Double declining balance DDB(cost, salvage, life, period, factor)
Sum of years' digits SYD(rnst, saJvage, life, period)
Variable declining balance VDB(cost, salvage, life, start__period, end_period, fact01~ no_switch)
MA:CRS for period t VDB(cost, 0, life, max(O, t-1.5), min (life, t-.5), factor)

SUMMARY
From the perspective of engineering economy, depreciation matters even though it is nor a cash flow. It is patt of
determining taxable income and the cash flow of taxes.
Depreciation is part of computing income taxes in economic analysis . There are three distinct definitions of
depreciation:
1. Decline in asset's market value.
2. Decline in asset's value to its owner.
3. Allocating the asset's cost less its salvage value over its recovery petiod or depreciable life.
While the first two definitions are used in valuing an asset or a firm, it is the third definition that is used in tax
computations and thus the focus of this chapter. Book value is the remaining unallocated cost of an asset, or

Book va1ue =A set co t - Depreciation charg made to date

This chapter describes how depreciable assets are written off (or claimed as a business expense) over a period of years
Instead of expensed in a single period (like wages, material costs, etc.). The depreciation methods described include the
classic methods: stmight-line and declining balance. These methods required estimating the asset's salvage value and
depreciable life.
The current tax law specifies use of 100% bonus depreciation and the modified accelerated capita] recovery system
(MACRS). ost new assets may now be expensed in their first year of use through 100% bonus depreciation. Those
assets that do not qualify for bonus depreciation continue to be depreciated using NIACRS, which is economically more
attractive than the classic methods. While histmical from a U.S. tax perspective, the classic methods are often used in the
U.S. when valuing assets and firms and internationally for both valuation and tax purposes.
The MACRS system assumes a salvage value of zero. This Is in contrast with histmical methods, which ensured the
final book va]ue would equal the predicted salvage value .. When using 100% bonus depreciation and often when using
MACRS, it is necessary to consider recaptured depreciation. This is the excess of salvage value over book value, and it is
taxed as ordinary income. SimHarly, losses on sale or disposal are taxed as ordinary income .
Unit-of-production (UOP) depreciation relies on usage to quantify- the loss in value. UOP is appropriate for assets that
lose value based on the number of units produced, the tons of gravel moved, and so on (vs. number of years in service).
However, this method is not considered to be acceptable for most business assets.
Depletion is the exhaustion of natural resources like minerals, oil and gas, and standing timber. The owners of the
natural resources are consuming their investments as the natural resources are removed and sold. Cost depletion is
computed based on the fraction of the resource that is removed or sold. For minerals and some oil and gas wells, an
alternate calculation called percentage depletion is allowed . Percentage depletion is based on income, so the total
allowable depletion deductions may exceed the invested cost.

STUDENT STUDY GUIDE

These questions are intended for self-study. Click the [solution] box to reveal a detailed solution.
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.., ,._,. ,._ ...,. ,._ "'1....._ ,.__..,. ._._.,._..,.., ......., .._ ..... .._ .. .._.._....__., .._ ...., ,._ ,.... _.._._ ..,..._,..._ .....,J ■ ......,...,._ ._ _••. ..,._.. ._ L..,,_,.,._.....,....._...,. ••..J ....,. ...,~,., .,_,_,. ..._.._ ~ .._.._..._ ..,., ,..._.._~.._ • ..._.._. ...,...,._.....,._....._....,.._ ....

11- Equi pment that qualifies for 100% bonus dep redation was purchased for $250,000. Dete1m1ne the depredation scheduJe.
1
►iHGiM§i
11- Production equjpment has a cost basis of $200,000 and an expected sa.lvage value of $20,000. TMs equipment qualifies for bonus
2 depreciation. How much bonus depreciation is allowed?
a. in 2020?
b. in 2024?
c. in 2026?

►i• 1 ••Pi 0 R 1
11- A piece of m ach inery costs $5000 and has an anticipated $1000 resale value at the end of its 5- year useful life. Compute the
3 depreciation schedule for the machinery by the straight-line method.

►i• 1 ••Pit•R 1
11- Seed-clean ing equipment was purchased in 2018 for $8500 and was depreciated by the double decUning balance (DDB) method
4 for an expected life• of 12 years. What is the book val ue of the equipment at the end of 2023? The original salvage value was
estimated to be $2500 at the end of 12 years.

►W•!iim§•
11- Suds-n-Dogs just purchased new automated bun-handl.ing equipment for $12,000. The salvage vaJue of the equipment is
5 anticipated to be $1200 at the end of its 5-year Hfe. Use MACRS to dete1mine the depreciation schedule usin g a three-year
property class.

►i•1 • 11 idi 1
11- To meet increased sales, a large dairy is planning to purchase 10 new delivery trucks. Each truck will cost $18,000. Compute the
G depreciation schedule for each truck, using the modified accelerated cost recovery system (MACRS) method ; the remvery pe1iod
is 5 years.

►i• 1 ••Pi 0 R 1
11- An asset is purchased for $100,000. The asset is depreciated by using MACRS depreciation and a 5-year ~ecovery period. At the
7 end of the third year of use, the business changes its product mix and disposes of the asset. Determine the depreciation allowed in
the third year.

►i.,•!ii@i
11- A finn is purchasing office furniture worth $200,000 that has an expected salvage value of $20,000. The furni ture is a MACRS 7-
8 year property, but is aJso eligible for 60% bonus depreciation. Calculate the depreciation s.ched ule.

►i•1 •!ii 0R 1
11- Computers worth $50,000 are eligib le for 20% bonus dep redation plus MACRS . Determine the depreciation schedule.
9
►M•!ii@i
11- An asset will cost $1750 w hen purchased this year. It is fmther expected to have a salvage value of $250 at the end of its 5-year
10 depreciable life. Calculate complete depreciation schedules giving the depredation charge, D(n), and end~of-year book vafae,
B(n), for straight-line (SL), double dedin ing balance (DDB), 100% bonus depreciation, and modified accelerated cost recovery
(MACRS) depredation methods. Assume a ACRS recovery period of 5 years.

11- Your company is considering the purchase of a secondhand scanning mkroscope at a cost of $10,500, with an estimated saJvage
11 value of $500 and a p rojected useful life of 4 years. Determine the straight-line (SL), and double decUning balance (DDB)
depreciation schedules.

11- A new machine costs $12,000 and has a $1300 salvage value at the end of its 8-year useful life. Prepare a year-by-year
12 depreciation schedule by the double declining balance (DDB) method.

►M•!ii 0ii
11- A used piece of depreciable property was bought for $20,000. If it has a us.eful life of 10 years and a saJvage value of $5000, and
13 you use the 150% declining balance schedule, how much wil] it be depreciated in the 3 rd year?

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J ...,...., .................. .._ ........ ..... ,-v .................. _. .... b , .... -.................. .... ......... .._ ............... , •• ...,. •• ...... .............. , ........ ......................... .t'~ ... .._ ... ....,_...,.,_...., •.
~~ ...... .._ ..... .} .._ ...... ·•

W-W•Gi0ii
11- A front-end loader costs $70,000 and has a depreciable sa.lvage vaJue of $10,000 at the end of its 5-year useful life. Use MACRS
1A depreciation to c-ompute the depreciation schedule and book value of the equipment.
Wi•jii,iM§i
11- A pump cost $1000 and has a salvage value of $100 a ter a life of 5 years. Using the straight-line depreciation method, determine:
15
a. The depredation in the first year.
b. The book value after 5 years.
c. The book value after 4 years if the salvage was only $50.

11- uts-R-Us, Inc. purchased nut-sheJling equipment at a total cost of $80,000. The equipment was depreciated by using ACRS
16 with a recovery class of 3 years and an anticipated end-of-usefuJ-life value of $8000. The c-ompany has decided the equipment is
110 longer needed after two years and wishes to determine the minim um value it can accept for the equipment (that is, the lowest
value that will result in no loss on the sale). Find the minimum selling price for the equ.ipment.
Wi•1•Gihi1
11- Thick Trunk Sawmil.l purchases a new automated log planer for $95,000. The asset is depreciated by us.ing straight-line
17 depredation over a useful life of 10 years to a salvage val ue of $5000. Find the book value at the end of Year 6.

11- Adventure Airlines recently purchased a new baggage crusher for$ 0,000. It is in a MACRS 7-year pmperty cl ass with estimated
18 salvage value of $8000. Use 40% bonus depreciation with MACRS to determine the depreciation charge on the crusher for the
third year of its life and the book value at the end of 3 years.

11- Hoppy Hops, Inc., purchased hop-harvesting machinery for $150,000 four years ago. Owing to a change in the method of
19 harvesting,. the machine was recently sold for $37,500. Determine the MACRS deprecation schedule for the machinery for the 4
years of ownership. Assume a 5-year property class. What is the recaptured depreciation or loss on the sale of th,e mac.hinery?
Wi•1•Gi081
11- Equipment costing $100,000 was bought in early 2019 and sold three )'ears later for $20 000. Determfoe the depreciation
20 recapture, ordinary losses, or capital gafos associated with selling tile equipment. Consider two cases:
a.. 100% bonus depreciation
b. 5-year MACRS
Wi•1•GiM§.1
11- A lumber company purchased a tract of timber for $70,000. The value of the 25,000 trees on the tract was establ.ished to be
2.1 $50,000. The va.lue of the land was established to be $20,000. In the first year of operation, the lumber company cut down 5000
trees. What was the depletion aJJowance for the year?

11- In the production of beer~ a final filtration is accomplished by the use of kieselguhr, or diatomaceous ea1th,. which is com posed of
22 the fossil remains of mi nute aquatic alg,ae a few microns in diameter~ and pure silica. A company has purchased a property for
$840,000 that contains an estimated 60,000 tons of kiese]guhr. Compute the depredation charges for the first 3 years, given that
production (or extraction) of 3000 tons, 5000 tons, and 6000 tons is pfanned for Years 1, 2, and 3, res pectively. se the cost-
depletion methods, assuming 110 sa.lvage value for th.e property.
Wi•1•Gi0ii

PROBLEMS
Key to icons.: D = click to reveal answer; m= Green, which may include environmental ethics; CJ =Ethics other than
green; = autograded prob]ems that are avaHable online in Dashboard; = The icon indicates that a spreadsheet is
recommended.
Assume that the depreciation methods listed In each problem can be used for tax and valuation purposes .

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Bonus Depredation
11- A meta] fabrication company is buying a CNC machine for $600,000. After 20 years of use, the machine should have a salvage
1 value of $35,.000.
(a) Under 100% bonus dep11eciation, what depreciation can be claimed in year 1?
,(1:1) Under 100% bonus dep11eciation, what depreciation can be claimed in year 2?
11- A manual press costs $16,000, and it will be scrapped after 10 years. Compute the depreciation and book vaJue for the first t.'>'o
2. years using 100% bonus depreciation .
I
11- Using 100% bonus depreciation, determine the depreciation schedu]e for $375,000 worth of equipment that was purchased by a
3 smal.l design firm in 2018. The film had no other capital expen ditures.
11- A small, profitable construction contractor purchased equipment costing a total of $1,600,000 in 2018. Using Section 179
4 expensing first, and then 100% bonus depreciation, determine the depreciation sched ule for the equipment.
I
11- achinery fo r an assembly line has a cost basis of $150,000 and an expected salvage of $25,000. It is not subject to special
5 limitations for bonus depreciation. How much bonus depreciation was, is, or wilJ be alJowed
(a) .in 2014?
,(I:,) in 2018?
(c), in 2014?
,(d) in 2016?
11- ach.inery fo r an assembly line has a cost basis of $150,000 and an expected salvage of $25,000. It is not subject to special
6 limitations for bonus depreciation. How much bonus depreciation was, is, or wilJ be alJowed
I •(a) in 2014?
,(1:1) in 2018?
(c), in 2024?
(d) in 2026?

Depredation Schedules
11- For an asset that fits into the MACRS "all property not assigned to another class" designation, show in a table the depreciation and
7 book value over the asset' s 10-year Life of use. The cost bas.is of the asset is $20,000.
11- A company that manufactures food and beverages in the vending industry has purchased some handling equipment that cost
8 $75,000 and will be depreciated using eith,er 100% bonus depreciation or 3-year MACRS. Show in a table for each method the
I yearly depreciation amount and book value of the asset over its depreciable Life.
11- A new machine tool is being purchased for $25,000 and is expected to have a zero salvage vaJue at the end of its 5-year useful life.
9' Compute its DDB depreciation schedule. Assume any remaining depredation is claimed in the Last year.
11- Gamma Crufr,e, Inc. purchased a new tender (a small. motorboat) for $35,000. ]ts salvage value is $7500 after its usefoJ life of

•
10 years. Calculate the depreciation schedul.e using (a) MACRS and (b) 100% bonus deprecia tion methods .

11- A $5 milHon oil drming Iig has a 5-year depreciable life and a $250,000 salvage value at the end of that time.
~ ,(a) Detennine which one of the foUowing methods provides the prefeITed depreciation schedule: 100% bonus depreciation or
..i., MACRS.
(1:1) Show the dep recia tion schedule for the prefen-ed method.
(c), Search for new oil rig technologies and descr.ibe three that improve ,environmental impact.
11- The RX Drug Company has just pmchased a capsulating machine for $76,000. The plant engineer estimates the machine has a
12. useful Ufe o 5 years and no salvage value. Compute the depreciation schedule using:
I ,(a) Straight-line depreciation
,(1:1) Double declining balance depreciation {assume any 11emaining dep reciation is claimed in the last year)
•(c), 100% bonus depreciation
,(d) MACRS
11- Some special handling devices can be obtained for $20,000, At the end of 5 years, they can be sold for $2000. Compute th,e
13 depreciation schedule for the devices using the fo]Jowing methods:
,(a) Straight-Line deprecia tion
llh) nrn ,hlP rlPrli nino· h;il::mrP rlPnrPrb tinn
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•(ll) Double declining bal ance depreciation
{c), 100% bonus depreciation
( d) MACRS depreciation

11- The company treasurer must determine the best depreciation method for office furniture that costs $50,000 and has a zero salvage
14 value at the end of a 10-year depreciable life. Compute the dep reciation sdledu]e using:
0 (a) Straight ]jne
(ll) Double declining balance
(c), 100% bonus depreciation
{d) Modified accelerated cost recovery system
11- Th.e Acme ChemicaJ Processing Company paid $50,000 for research equipment, whkh it bel.ieves will have zero salvage vaJue at
15 the end of its 5-year life. Compute the depreciation sched ule using:
{a) Straight Une
•(ll) Double declining balance
(c), 100% bonus depreciation
{d) Modified accelera ted cost recovery system
(e), What is the U.S. EPA's Presjdential Green Chemistry Challenge? What impact has this initiative had on green chemical
processing?
11- Units-of-prod uction depreciation is being used for a machine that, based on usage, has an allowable depreciation charge of $6500
16 the first year and increasing by $1000 each year until complete depreciation. If the machine's cost basis is 110,000,. set up a
I depreciation schedule that shows depreciation charge and book value over the macMne's lO~year useful life.
11- Consider a $6500 piece of machinery, with a 5-year depreciable life and an estimated $1200 salvage value. The projected
17 utilization of the machinery when it was purchased, and its actuaJ production to date, are as folJows:
Year Pr,ojected Production (tons) Actual Production (tons)
1 3500 3000
2 4000 5000
3 4500 [Not
4 5000 yet
5 5500 known]
Compute the depreciation schedule usfog:
{a) Straight Une
(ll) Double declining balance
(c), 100% bonus depreciation
,(d) MACRS
{e), Unit of prnduction (for flrst 2 years only)
11- Al Jafar Jewel Co, purchased a crystal exn·action mach.ine for $50,000 that has an estimated salvage value of $10,000 at the end of
18 its 8-year useful life. Compute the depreciation schedule using:
I {a) Straight-line depreciation
•(ll) Double declining balance depreciation
{c), 100% bonus depreciation
( d) MACRS depreciation
11- The depreciation schedule fo r a machine has been arriv,ed at by several methods. The esti.mated salvage value of the equipment at
19 the end of .its 6-year usefuJ life is $600. Identify the resulting depredation schedules.
Year A B C D
1 $8000 $2000 $1600 $1233
2 0 1500 2560 1233
3 0 1125 1536 1233
4 0 844 922 1233
5 0 633 922 1233
6 0 475 460 1233
11- Consider five depreciation schedules:
: IYear I A I B I C I D E

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- - -- -- - - - -
I 1 $135.00 $35.00 $29.00 $58.00 $43.50
2 0.00 20.00 46.40 34.80 30.45

Year A B C D E
3 0.00 30.00 27.84 20.88 21.32
4 0.00 30.00 16.70 12.53 14.92
5 0.00 20.00 16.70 7.52 10.44
6 8.36
They are based on the same initial cost, useful life, an d saJvage value. Identify each schedule as one of the foUowing:
• Straight-line depreciation
• 100% bonus depreciation
• 150% decJjning balan ce depredation
·• Double declining balance depredation
• Unit-of-production depreciation
• Modified accelerated cost recovery system
11- The depredation schedule for an asset, with. a salvage value of $90 at the e.nd of the recovery period, has been computed by
2.1 several methods. Identify the depredation method used for each schedule.
Year A B C D E
1 $1060.0 $212.0 $424.0 $194 .0 $107.0
2 0 339.2 254.4 194 216
3 0 203.5 152.6 194 324
4 0 122.1 91.6 194 216
5 0 122.1 47.4 194 107
6 61.1
1060 1060 970 970 970
11- A heavy construction finn has been awarded a conn11ct to build a large concrete da.m. It is expected that a total of 8 years will be
2.2 required to complete the work The £inn will buy $600,000 worth of special equipment for the job. During the preparation of the
I job cost estimate, the following utilization schedule was com puted for the special equipment:
Year Utilization (hr/yr) Year Utilization (hr/yr)
1 6000 5 800
2 4000 6 800
3 4000 7 2200
4 1600 8 2200
At the end of the job, it is estimated that the equipment can be sold at auction for $60,000.
(a) Compute the straight-line depredation schedule.
(lb) Compute the unit-of-production depreciation schedule.
11- A profitable company making earthmoving equipment is considering an i.nvesnnent of $150,000 on equjpment that wiJJ have a 5-
23 year useful life and a $50,000 salvage va.lue. sea spreadsheet to compute the 60% bonus depreciation with MACRS depreciation
Q schedule. Show the total depreciation taken (=sum()) as well as the PW of the depredation charges discounted at 10%.
11- A custom-built production machine ls being depreciated using the units~of-production method. The machine costs $65,000 and is
24 expected to produce 1.5 million units, after which lt will have a $5000 salvage value. In the first 2 yea.rs of operation the machine
I was used to produce 140,000 units each year. In the 3rd and 4th yea.rs, production went up to 400,000 units. After that time annual
Q production returned to 135,000 unjts. Use a spreadsheet to develop a depredation schedule showing the machine's depredation
allowance and book value over its depreciable life.
11- You are equipping an office. The totaJ office equipmem will have a first cost of 2.0M and a salvage value of $200,000 . You expect
25 the equjpment w:iJJ last 10 yea.rs. Use a sp!'eadsheet to compute the 40% bonus depreciation with MACRS depreciation schedule.
Q
11- Office equipmellt whose initial. cost is $100,000 has an estimated actua.1 life of 6 years, with an estimated salvage vaJue of
2.G $10,000. Prepare tables listing the annual. costs of depredation and the book value at the end of each 6 years, based on straight-
I line, do ubl.e declining balance, 100% bonus depI1eciation, and ACRS depredation. Use a spreadsheet to show the depredation
Q methods .
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Cmnparing Depreciation Methods

11- The XYZ Bloc.k Company purchased a new office computer and other depreciable computer hardware for .$12,000. During the
27 thi.rd year, the compmer is dedared obso]ete and is donated to the local community college. Using an in terest rate of 10%,
G caJculate the PW of the depreciation deductions. Assume that no salvage value was in itially declared and that the machine was
expected to last 5 years.
•(a) Straight-line deprecia tion
(h) Double declining balance depreciation
,(c), 100% bonus depreciation
,(d) MACRS depredation
,(e), Which method is preferred for determining the firm's taxes?
(f) Which method is preferred for determining the fi rm' s value?
(g) Is using two accounting methods ethical?
11- Some equipment that costs .$1000 has a 5-year depreciable life and an estimated $50 salvage value at the end of that time. You
2B have been assigned to determine whether to use straight- Line or double declining baJance depreciation. If a 10% interest rate is
I appropriate, which is the prefened depredation method fo r this profitable corporation? Use a. spreadsheet to s.h ow your
Q computations of the difference in present worths.
11- The FOURX Corp. has purchased$ 0,000 of experimental equipment. The anticipated salvage value is .$5000 at the end of its 5-
2'9 year depreciable life. This profitable corporatio n is considering two methods of depreciation: straight-line and double declining
~ balance, If it uses 10% interest in its comparison , which method do you recommend? Use a spreadsheet to develop your solution.

11- The White Swan Tak Company paid .$120,.000 for mining equipment for a smaU taJc mine . The mining engineer's report indicates
30 the mine contains 40,000 cubic meters of commercial-quality talc. The company plans to mine all the talc in the next 5 years as
(9 follows:
Year Tole Prod11c1ion (m3)
1 15,000
2 11,000
3 4,000
4 6,000
5 4,000
At the end of 5 years, the mine will be exhausted and the mining equipment will be worthless. The rnmpany accountant must now
decide whether to use double declining balance depredation or unit-of-production depreciation. The com pany considers 15% to be
an appropriate time value of money.
,(a) Which would you rernmmend? How much better is the present worth for the recommended choice?
•(h) What is talc and how is it used? As the softest mineraJ, are there special health and environmental. issues/ris ks that are present
in the mining, processing, and use of talc?
11- A small us.ed deJivery van can be purchased for $20,000. At th,e end of its useful life (8 years), the van can be sold for $3000.
31 Detennine the PW of the depreciation schedule based on 15% interest using:
(a) Straight-line depreciation
,(h) Double declining balance depreciation
,(c), 100% bonus depreciation
·(d) MACRS depredation
11- Loretta Liven:nore Labs purchased R&D equipment costing $200,000 . The interest rate is 5%, salvage value is $20,000, and
32 expected life is 10 years. Compute the PW of the depreciation deductions assuming:
I (a) Straight-line deprecia tion
(9 (h) Double declining balance depreciation
(c), 100% bonus depreciation
,(d) MACRS depreciation
,(e), Which method is preferred for determining the firm' s taxes?
,(f) Which method is preferred for determining the firm' s value?
,(g) Is using two accounting methods ethical?

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Depredation and Book Value

11- Explain in your own words the difference betwe;en capita] gains and ordinary gains. In addition, explain why it is important to our
33 analysis as engineering economists. Do we see capita] gains much in industry-based economic analyses or in ourperwna] lives?
11- The MACRS depredation percentages for 7-year persona.I property are given in Table 11-2. Make the necessary computations to
34 determine if the percentages shown are correct.
11- The CRS depreciation percentages for 10-year personal property are given in Table 11-2. Make the necessary computations to
35 determine if the percentages shown are con-ect.
11- For its fabricated meta] products, the Able Corp. is paying $10,000 for spedaJ tools that have a 4-year useful life and no sa]vage
3G value. Compute the depredation charge for the second year by each of the following methods:
I •(a) Straight-line
,(fb) Doub]e declining balance
(c), 100% bonus depreciation
(d) Modified accelerated cost recovery system
11- Global. Fitters, an intemationa] clothing company, has purchased material handling equ.ipment that cost $100,000 and a salvage
37 value of SlB,000 after 10 years . Determine the book value of the equipmen t after 3 years using:
G (a) Straight-1.ine depreciation
(fb) 150% decUning balance depreciation
(c), 100% bonus depreciation
•(d) 7-year ACRS depreciation
,(e), Globa.l Fitters u:ses low-rnst labor in emerging wodd economies to manufacture its products. List three potential ethical
issues that are associated with the use of this .labor pool.
11- A pump in an ethylene production pfant costs $15,.000. After 9 years, the salvage value is declared at $0.

•
38 (a) Detennfoe depredation charge and book value for Year 9 using straight-line, 100% bonus depredation, and 7-year ACRS
depredation.
(fb) Find the PW of each depreciation schedule if the interest rate is 5%.
11- A used d1ill press costs $60,000, and delivery and installation charges add $5000. T he saJvage value afte r 10 years is $10,000.
39 Compute the accumulated depreciation through Year 5 using
(a) Straight-line depreciation
(fb) Double declining balance depredation
(c) 60% bonus depreciation with the balance using 7-year MACRS
11- etal Stampings,. Inc., can purchase a new forging machine fo r $100,000. After 20 years of use the forge should have a salvage
40 value of SlS,.000. Vvhat depreciation is allowed for this asset in Year 3 for
I (a) Straight-line depreciation?
,(fb) Double declining balance depredation?
(c), 40% bonus depreciation with the balance using MACRS?
11- uddy eadows Earthmoving can purchase a bulldozer for $150,000 . After 7 years of use, the bulldozer should have a salvage
41 value of $50,.000. Vvhat depredation is al.lowed for this asset in Year 4 for
,(a) Straight-line depreciation?
(fb) 150% declining balance depreciation?
(c) 40% bonus depredation with the balance using 5-year MACRS?
11- An asset costs $150,000 and has a salvage value of $15,000 after 10 years. What is the dep reciation charge for tl1e 4th yea1~ and
4.2 what is the book value at the end of the 811, year with
I (a) Straight-1.ine deprecia tion?
•(fb) Double declining balance depredation?
(c), 60% bonus depreciation with the balance using 7-year MACRS?
11- A precision five-axjs C C milling machine costs $200,000,. and it will be scrapped after 10 years . Compute the book value and
43 depreciation for the first 3 years using
(a) straigbt-Une depreciation
,(fb) double declining balance dep reciation
(c), 150% declining balance depreciation
,(d) 100% bonus depreciation
(e), MACRS depreciation

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11- A company is considering buying a new piece of machinery. A 10% in terest rate will be used jn the computations. Two models of
J
44 the machine are available.
I I IMachine I I Machine II

Machine I Machine II
Initial cost $80,000 $100,000
End-of-useful-life salvage value, 5 20,000 25,000
Annual operating cost 18,000 15,000 fi rst 10 years 20,000 thereafter
Useful Iife, in years 20 25
MA:CRS class 7yr 7yr
(a) Detennine which machine should be purchased, bas.ed on equivalent uniform annual cost
(lb) What is the cap italized cost of achine I?
(c), Machine I is purchased and a fund is set up to replace Machine I at the end of 20 years. Compute the requi11ed uniform annual
deposit.
{d) Machine I will produce an annual saving of mate1ia.l of $28,000. What is the rate of return if Machine I is installed?
(e), What wiU be the book value of Machine I after 2 years, based on 60% bonus dep11eda1ion with the balance using MACRS?
(f) What wrn be the book vaJue of Machine II after 3 years, bas.ed on straight-line depredation?
{g) What would be the MACRS depreciation in the thi.rd year for Machine 11?

Gain/Loss on Disposal
11- Equipment costing $20,000 that is a MACRS 5-year property is disposed of during the second year for $15,000. Calculate any
45 depreciation recapture, ordinary loss.es, or capital gains associated with clisposaJ of the equip ment.

11- An asset costing $50,000 was purchased on January 1, 2019. Cakulate any depreciation recapture, orcUnary losses, or capital gains
46 associated with sellin g the equipment on De,cember 31, 2021, for $15,000, $25,000,. and $60,000. Cons.ider two cases of
I depreciation for the problem : if 5-year MACRS is used, and if 100% bonus depredation is used.
11- A purchased machine cosl $320,000 with deUvery and installation charges am ounting to $30,000. T he declared salvage value was
47 $50,000. Early in Year 3, the company changed ils product mix and found thal it no longer needed the machine . One of its
competitors agreed to buy the machin e for $180,000. Determine th e loss, gain, or recaptu.re if (a) 100% bonus depreciation is
used, and (b) if MACRS depreciation is used. Use a 7-year MACRS dass.
11- O' Leary Engineering Corp. has been depreciating a $50,000 ma.chine fo r the last 3 years . The asset was just sold for 60% of .its
48 fi rst cost. What js the size of the recaptured depreciation or loss at disposal using the following depreciation methods?
I {a) Sn·aight-line with N = 8 and S = 2000
{lb) Double declining balance with.N = 8
•(c), 40% bonus depredation with the balance using 7-year MACRS
11- A $150,000 asset has been depreciated with the straight-line method over a 10-yea.r life. The estimated salvage value was $30,000.
49 At the end of the 7lli year the asset was sold for $38,000. Prom a tax perspective, what is happen ing at the tim e of disposal, and
what is the dollar amollnt?
11- A numerically controlled rniUing machine was purchased for $95,000. The estimated salvage val ue was $15,000 after 15 years.
50 What is lhe machine's book value aher 5 years of depreciation ? H the machine is sold for $20,000 early in Year 7, how much gain
I on saJe or recaptured depredation is the11e? Assume
(a) Sn·aight-line deprecia tion
(lb) 150% declining balance depredation
•(c), 80% bonus depreciation with the balance using 7-year MACRS depredation
{d) 7-year MACRS depreciation
11- A computer costs $3500 and its salvage value in 5 years is negligible. What is the book value after 3 years? If the machine is sold
51 for $1500 in Year 5, how much gain or recaptured depreciation is there? Assume
(9 •(a) Straight-line deprecia tion
•(lb) Double declining balance depreciation
,(c), 20% bonus depreciation with the balance using 5-year MACRS
,(d) MACRS depreciation
,(e), There are two important considerations when disposing of old compute.rs-one environmental and one personal. What are
they, and how can you lessen the effect of each?
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11- A belt-conveyor purchased for $140,000 had shipping and instalJation costs of $20 000. 1t was expected to last 6 years, when it
52 would be sold fo r $25,000 after paying $5000 fo r dismantling. Instead, it lasted 4 years, and several workers were permitted to
I take it apart on thei.r own time for reassembly at a private technical school. How much gain , loss, or recaptured depreciation is
there? Assume
•(a) Straight-line depreciation
(fb) 150% decHning balance depreciation
,(c) 40% bonus deprec:iati.on with the balance using 7-yea.r MACRS
(d) 7-year ACRS

Depletion and Unit-of-Production

11- A pie('le of machinery has a mst basis of $50,000. Its salvage value wiJJ be $5000 after 9000 hours of operation. With units-of-
53 prod uction depreciation, what is the allowable depreciation rate per hou.r? What is th,e book val ue after 4000 hours of operation?

11- When a major highway was to be constructed nearby, a farmer reaJized that a dry streambed running through his property might
54 be a valuable source of sand and gravel He shipped samples to a testing laboratory and learned that the mateliaJ met the
I requirements for certain low-grade fill material. The farmer contacted the highway construction contractor, who offered 6 ¢' per
cubic meter for 45,000 cubic meters of sand and gravel. The contractor would build a hauJ road and would use his own equipment.
All activity would take place during a single summer.
The farmer hired an engineering student for $2500 to count the tn.1ckloads of material hauled away. The fanner estimated that 2
acres of st11earn bed had been stripped of the sand and gravel. The 640-acre farm had cost him $300 per acre, and the farmer felt the
property had not changed in value. He knew that there had been no use for the sand and gravel prior to the const:n.1ction of the
highway, and he could foresee 110 future use fo r any of the remain ing 50,000 cubic meters of sand and gravel.
Determine the fa1mer's depletion al.lowance.
11- During the construction of a highway bypass, earthmoving equipment costing $40,000 was purchased fo r use in transporting fill
55 fro m the borrow pit. At the end of the 4-year project, the equipment will be so]d for $20,000. The schedule for moving fill calls
for a total of 100,000 cubic feet du.ring the project. ln the first yea1~ 40% of the totaJ fill is required ; in the second year, 30%; in the
third year, 25%; and in the final year, the remaining 5%. Determine the units-of-production depredation schedule for the
equipment
I
11- r. H. Salt purchased an 8 interest in a producing oiJ well for $45,000. Recoverable oiJ rese1ves for the well were estimated at
56 I
I that time at 1s,roo barrels, 8 of which repre!">ented Mr. Salt's share of the reserves. During the subsequent year,. Mr. Salt received

$12,000 as his 8 share of the gross income from the sale of 1000 barrels of oil. From this amount, he had to pay $3000 as his share
of the expense of producing the oil. Compute r. Salt 's depletion allowance for the year.
11- The Piney Copper Company purchased an orebearing tract of land for $10.0M. TI1e geologist for Piney estimated the recoverable
57 copper reserves to be 500,000 tons. During the firs t yea1~ 0,000 tons were mjned and 40,000 tons were sold for $5.0 . Expenses
C9 (not including depletion allowances) were $3.0M.
,(a) What are the percentage depletion and the rost depletion aJJowances?
,(fb) Copper mining and production are subject to high Jevels of regulation, including conn--o] of air and water quality as well as
materiaJs handling and disposal practices. What are the primary environmentaJ risks, and how has regulation lessened those
risks? What are the m ost significant heaJth risks, and how have these been lesf>ened?
11- American Pu.Ip Corp. {APC) has entered into a contract to harvest timber for $450,000. The total estimated available harvest is
58 150 million board-feet.
I ,(a) What is the depletion aUowanc-e fo r Yea.rs 1 to 3 if 42, 45, and 35 mill.ion board-feet a11e harvested by APC in thof>e years?
,(fb) After 3 years, the Iota] available harvest for the mig,inal tract was reestimated at 180 million Imam- feet Compute the
depletion allowances for Years 4 and beyond.
11- An automated assembly line is purchased for $2,500,000. The company has decided to use units-of-production depredation. At
59 the end of 8 years, the line will be scrapped for an estimated $500,000. Using the following infmmation, determine the
depreciation schedule for the assembly line.

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Year Pr@duction Level

1 5,000 units
2 10,000 units
3 15,000 units
4 15,000 units
5 20,000 units
6 20,000 units
7 10,000 units
8 5,000 units

11- Western Carolina Coal Co. expects to produce 125,000 tons of coaJ annually for 15 years. The deposit cost $3 to acquire; the
00 annual gross revenues are expected to be $9.50 per ton, and the net revenues are expected to be $4. 25 per ton.
I (a) Compute the annual depletion on a cost basis.
e ,(t,) Compute the annual depletion on a percentage basis.
(c), What are some of the primary environmental impacts of both surface and underground mining? What health risks do
underground miners fac-e? What is being done to make mining safer and more environmentally friendJy?
11- Eastern Gravel expects to produce 60,000 tons of gravel annually for 5 yea.rs. The deposit cost $150K to acquire; the annual gross
61 revenues a.re expected to be $9· per ton, and the net revenues are expected to be $4 per ton .
(a) Compute the annual depletion on a cost basis .
(1:1) Compute the annual depletion on a percentage basis.
11- A 2500~ac£e tract of timber is purchased by the Houser Paper Company for $1,200,000. The acquisitions depa1tment at Houser
62 estimates the land will be worth $275 per ac£e once the timber is cleared. The materials department estimates that a total of S
I million board-feet of timber are ava.i.lable fmm the tract. The ha1vest schedule caUs fo r equal amounts of the timber to be
harvested each yea[ for 5 years. Detennine the depletion aJJowance for each year.
11- ining recently began on a new deposit of 10 million metric tons of ore (2% nickel and 4% copper). Annual production of
63 350,000 metric tons begins this year. The market price of nickel. is $3. 75 per pound and $0.65 for copper. ining operation costs
are expected to be $0.50 pe.r pound. XYZ Mining Company paid $600 million for the deposits. What is the maximum depletion
al.lowance each year for the mine?
11- The Red River oil field will become less productive each year. Rojas Brothers is a small company that o.ms Red River, whi.ch is
G4 eligible for percentage depletion. Red River costs $2.5M to acq uire, and it win be produced over 15 yea.rs. Initial production costs
I are $4 per barrel, and the wellhead value is $10 per barrel. The first year's production is 90,000 ban-els, which wiU decrease by
6000 ban e]s per year.
{a) Compute the annual depletion each year may be cost-based or percentage-based).
(1:1) What is the PW at i = 12% of the depletion schedule?

CASES
The following case from Cases in Engineering Economy (www.oup.com/us/newnan) is suggested as D1atched with
this chapter.
CASE 2.6 Molehill & Mountain Movers
Compare depreciation metho ds w1th option for inflation.

I N ls used for the depreciation period because it may be shorter th<10 n, tile horizon (or JJroject life).

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CHAPTER 12
INCQ,M E TAXES FOR CORPORATIONS

Corporate Taxes Around the World: How to Compare?

In 2018, the U.S. lowered its federal statutory corporate income tax rate from 35% to 21%. For two decades, U.S.
corporate income taxes had been cited as the highest among developed nations. Thus, it was argued that U.S. companies
were moving their Investments internationally to avoid paying such high taxes. Is the statutory tax rate the appropriate
rate for comparison? If not, how does the U.S. actually compare with other developed nations?
There are three types of tax rates that are commonly used for comparisons.
• The statutory rate is the nominal rate set by Jaw. Attention is focused on the highest rate for higher incomes.
• The average rate is what firms actually pay. It equals taxes paid divided by profits. This includes the various tax
benefits that reduce a firm's taxable income.
• The marginal corporate rate is a measure of a firm's tax burden on returns from new projects.
All three measures influence firms' decisions. The average rate is useful when dete rmining whether to invest Jong-tem1 in
a pa11icular country. The marginal rate is useful when determining whether to expand ongoing projects . The statutory rate
is useful when developing legal and accounting strategies to shift income to counnies with lower taxes.
When compa1ing U.S. statutory corporate tax rates with those of other developed countries, prior to 2018 the
differences were indeed striking. U.S. rates exceeded average rates of other developed nations by almost 10%. However,
those differences are far less striking for actual taxes that firms in the U.S. paid after accounting for tax breaks. These
include subsidies for investments in research and development, production activities deduction, green energy credits, and
faster depreciation schedules, among others. A 2017 report by the Congressional Budget Office suggested that when
comparing average corporate income taxes in the U.S. and other developed countries, the U.S. firms actua1ly pay, on
average, closer to 19% in income taxes, less than some other deveioped countries.
With the new statutory corporate tax rate of 21 % introduced in 2018, expetts from the Economic Policy Institute
estimate that the effective corporate tax rate in the U.S. will likely be between 10% and 15%, which puts the U.S. well
below other developed nations. ■ ■ ■
Contributed by Eva Andrijcic, Rose-Hu/man Institt,ce of Teclmology

QUESTIONS TO CONSIDER

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1. Given that different met1ics are available for compating corporate income taxes across nations, which met1ic is
more objective and should be used?
2. Why is it more meaningful to compare U.S. corporate income taxes to those paid in other large, high-income
nations, rather than to taxes paid in low-income nations?
3. Films invest significant resources in tax planning to shift profits overseas to lower their corporate tax payments
in their home countries. These actions are legal, but are they ethical?

After Completing This Chapter ...

The student should be a.ble to:
• Calculate taxes due or taxes owed for corporations.
• Calculate a combined income tax rate for state and federal income taxes and select an appropriate tax rate for
engineering economic analyses.
• Utilize an a~er-mx tax table to find the after-tax cash flows for a prospective investment project.
• Calculate after-tax measures of metit, such as present wmth, annual wmt h, payback period, intemal rate of
return, and benefit-cost ratio, from after-tax cash flows.
• Evaluate investment ahernatives on an after-tax basis including asset disposal.
• Calculate personal incomes taxes and make choices about student loans, retirement accounts, insurance, and
personal budgeting. (Appendix 12A)

Key Words
after-tax cash flow table
capital expenditures
capital gain
capital loss
combined incremental tax rate
expensed
incremental tax rates
investment tax credit
taxable income

As Benjamin Franklin said, two things are inevitable: death and taxes. There are many types of taxes and structures for
taxation In the U.S., including sales taxes, gasoline taxes, prope1ty taxes., and state and federal Income taxes. In this
chapter we will concentrate our attention on federal income taxes for corporations. [.ncome taxes are part of most real
problems and ofien have a substantial impact that must be considered.
First. we must understand the way in which taxes are imposed. Depreciation is an integral pait of this analysis, so the
principles covered in Chapter 11 must be well understood. Then, having understood the mechanism, we will see how
federal income taxes affect our economic analysis .

A PARTNER IN THE BUSINESS

Probably the most straightforward way to understand the role of federal income taxes is to consider the U.S. government
as a partner in every business activity. As a partner, the government shares in the profits from every successful venture. [n
a somewhat more complex way, the government shares in the losses of unprofitable ventures too. The tax laws are
complex, and it is not our purpose to fully explain them. Instead, we wiJl examine the fundamental concepts of federal
income tax for corporations---we emphasize at the statt that there are exceptions and variations to almost every statement
we shall make!

CALCULATION OF TAXABLE INCOME

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At the mention of income taxes, one can visualize dozens of elaborate and complex calculations. There is some truth to
that vision, for there can be complexities in computing income taxes. Yet incomes taxes are just another type of
disbursement or cash outflow that affects profitabiHty. Our economic analysis calculations in prior chapters have dealt
with all smts of disbursements: operating costs., maintenance, labor and mate1ials, and so forth. ·ow we simply add one
more prospective disbursement to the list- income taxes.

Classification of Business Exp•e nditures

When an individual or a firm operates a business, there are three distinct types of business expenditure:
1. For depreciable assets.
2.. For nondepreciable assets.
3. All other business expenditures.
Expenditures for Depreciable Assets: When facilities or productive equipment with useful lives in excess of one
year are acquired. the firm will normaJly recover the investment through depreciation charges. Chapter 11 detailed
how to allocate an asset 's cost over its useful life .
Expenditures for Nondepreciable Assets: Land is considered to be a nondepreciable asset, for there is no finite life
associated with it. Other nondepreciab]e assets are properties not used either in a trade, in a business, or for the
production of income. The final category of nondepreciable assets comprises those subject to depletion, rather than
depreciation . Since business finns generally acquire assets for use in the business, their only nondepreciable assets
normally are land and assets subject to depletion.
All Other Business Expenditm·es: This category is probably the largest of all, for it indudes al] the ordinary and
necessary expenditures of operating a business . Labor costs, matelials, all direct and indirect costs, and facilities
and productive equipment with a useful life of one year or less are part of routine expenditures. They are charged
as a business expense-expensed-when they occur.
Business expenditures in the first tw·o categories-that is, for either depreciable or nondepreciable assets-are called
capital expenditures. In the accounting records of the firm. they are capitalized~all ordinary and necessary expenditures
in the third category are expensed.

Taxable Income of Business Firn1s

The statting point in computing a firm's taxable income is gmss income. AlJ ordinary and necessary expenses to conduct
the business-except capital expenditures-are deducted from gross income. Capital expenditures may not be deducted
from gross income. Except for land. business capital expenditures are allowed on a period-by-period basis through
depreciation or depletion charges .
For business fitms, taxable income is computed as follows:

Taxabl incom = Gros income (12-1)

- All expenditure except capital expenditures
- Depreciation and depletion charge
Because of the treatment of capital expenditures for tax purposes, the taxable income of a firm may be quite different
from the actual cash flows.

EXAMPLE 12-1
During a 3-year period, a firm had the following cash flows (in millions of dollars):

¥earl Year2 Year3

Gross 1ncome from sales $200 $200 $200
Purchase of special tooli11g -60 0 0
{useful life: 3 yea.rs)
All other •expe11ditures -140 -140 -140
Cash flows fo r the year $0 $60 $60

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Compute the taxable income for each of the 3 years.

SOLUTION
The cash flO\"IS for each year would suggest that Year 1 was a poor one, while Years 2 and 3 were very profitable. A
closer look reveals that the firm's cash flows were adversely affected in Year 1 by the purchase of special tooling.
Since the special tooling has a 3-year useful life, it is a capital expenditure with hs cost normally allocated over the
useful life. If we assume that straight-line depreciation applies with no salvage value, we use Equation 11-2 to find the
annual charge:

B- S 60 - 0
Annual depreciation charge = - - = -- = $20 million
N 3

Applying Equation 12-1, we write

Taxable income = 200 - 140 - 20 = $40 mi llion

In each of the 3 years, the taxable income is $40 million.

If we assume 100% bonus depreciation, the entire cost of the tooling is depreciated in Year 1. The taxable income is
then the same as the "Cash flows for the year" shown In the table.

Taxes are levied at the firm level- not at the project level. A project analysis may consider only the costs, it may have
a large bonus depreciation deduction in year 1, or a large CRS deduction in year 2. In each case the taxable income
may be negative for some or alJ years of the project. The negative taxes from the project's economic analysis will reduce
the taxes paid at the firm level. The negative taxes can be thought of as a tax credit. Even if a fitm has an unprofitable
year, the tax law includes caITy-forward and -backward provisions to transfer tax reductions to profitable years .

INCQ,M E TAX RATES

Corporate Tax Rates

The Tax Cuts and Jobs Act simplified and reduced federal corporate income tax rates (see Table 12-1) from eight tax
brackets to one flat tax rate of 21 % beginning in 2018.

Tull>I~ 12-1 C orporate Income Tux Rates

2017 2018
TacXa ble In come TacX Tax
Rate Ra,t e

Not over 50,000 15%

50 000--75,00{) 25 %
75 ,000--1 00,000 34%
IO0 000--335 000 39%
335,000-- 10 million 34% 21%
10 mi Uion-1 5 million 35%
15 mi llion-18,333,333 38%
:::$ 18,333.333 35%

EXAMPLE 12-2
A firm expanded one of its manufacturing operations inside an existing building. New processing and packaging
equipment was purchased for $800,000. Sales revenue for the year was $1.25 miJlion. Operating expenses for that year,
not including the capital expenditures, were $360,000. The new equipment qualifies for 100% bonus depreciation.
(f) What is the first-year depreciation charge?
(ii) What is the first-year taxable income?
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.,
(ui)What are the federal income taxes for the year?

SOLUTION
The new equipment qualifies for 100% bonus depreciation, so

Pi:rst-year depreciation = $800,000

Taxable income = Gross income - operating expense - depredation
= $1,250 000 - 360,000 - 00,000 = $90 000
Federal income tax = $90,000 x 0.21 = 18,900

EXAMPLE 12-3
The equipment in Example 12-2 qualifies for 40% bonus depreciation instead of 100% bonus depreciation. The
equipment is in the MACRS 7-year property class.
(a) What is the first-year depreciation charge?
(b) What is the first-year taxable income?
(c) What are the federal income taxes for the year?

SOLUTION TO PART a
The new equipment qualifies for 40% bonus depreciation, so the first 40% of the capital is expensed in the first year.

Bonus depreciation = $800,000 x 0.4 = 320 000.

In addition, MACRS depreciation is used to depreciate the remaining $480,000 (60% of the capital cost).

First-year11ACRS depreciation = 0 .1429 x 480,000 = $68 592.

Total first-year depreciation = 320,000 + 68,592 = $388,592
SOLUTION TO PARTS b AND c
Taxable income = Gross income - operating expense - depreciation
= $1,250,000 - 360,000 - 3&8,592 = $501 408
Federn.l incom tax = $501 408 x 0.21 = 105.296

Federal income tax rates are now fixed at 21%, but state income tax rates can vary depending on the level of taxable
income, as demonstrated in Example 12--4. Many states use incremental tax rates to determine corporate and personal
taxes.

EXAMPLE 12-4
A company in Kentucky has taxable income of $160,000. The Commonwealth of Kentucky taxes corporate income
with a series of marginal rates. Taxable income up to $50 ,000 is taxed at 4%, income over $50,000 up to $100,000 is
taxed at 5%, and income over $100,000 is taxed at 6%.
(i) How much income tax is owed?
(i.i) What is the marginal (incremental) tax rate?
(iii)What is th e average tax rate?

SOLUTION

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Tax = 0.04 x 50 000 + 0.05 x (lOO 000 - 50,000) + 0 .06 x (160,000 - 100.(IOO) = $8100
Marginal tax rate is the rate on the next 1 of income = 6 %,
Average tax rate = 8100/ 160,000 = 0.0506 = 5.06%

Con1bined Federal and State Income Taxes

With the decrease in federal tax rates, state taxes are of increased importance. It would be convenient if we could derive a
single tax rate to represent hath the state and federal incremental tax rates. ln the computation of taxable income for
federal taxes, the amount of state taxes paid is one of the allowable itemized deductions. Federal income taxes are not
deductible in the computation of state taxable income-except in a handful of states. Therefore, the state income tax is
applied to a larger taxable income than is the federal income tax rate. As a result, the combined incremental tax rate will
not be the sum of two tax rates.
For an increment of income (i1Income) and tax rate on incremental income (8Tax rate):
State income. taxes ti.State tax rate)( ti.lncome)
Federal taxable income ti.Income I - ti.State tax rate
Federal income taxes ti.Federal tax rate ti.Income, x (1 - ti.State tax rate)

The total of state and federal income taxes is

[ti.State tax rate (ti.Federal tax rate)(l - ti.State tax rate)](ti.Income

The term in the brackets gives the combined incremental tax rate.
ombi11ed incrernental t"3x rate (12-2)
= ti.State tax rate + ti.Federal tax rate 1 - ti.State tax rate

EXAMPLE 12-5
A small design firm is located in Pennsylvania where the state tax rate is 9.99%. Income taxes need to he considered as
the firm bids for new projects. What is the firm's combined federal and state income tax rate on new income?

SOLUTION
Using Equation 12-2, the combined incremental tax rate is:
= 0.0999 0.21(1 - 0.0999) = 0.2889 = 28.89%.

Since state income tax rates may vary with the level of taxable income one must decide which tax rate to use in a
particular situation. The simple answer is that the tax rate to use is the incremental tax rate that applies to the expected
change in taxable income projected in the economic analysis.

ECONOMIC ANALYSIS TAKING INCOME TAXES INTO ACCOUNT

An Important step In economic analysis has been to resolve the consequences of alternatives into a cash flow. Because
Income taxes have been ignored, the result has been a before-tax cash flow. This before-tax cash flow 1s an essential
component in economic analysis that also considers the consequences of income tax. Decision making is often done on a
before-tax basis. With 100% bonus depreciation before-tax and after-tax rates of return can be the same, as wi11 be shown
in Example 12- 8. The principa] elements in an a~er-tax analysis are as follows:
• Before-tax cash flow
• Depreciation
• Taxable income (Before-tax cash flow - Depredation)
• Income taxes (Taxable income x Incremental tax rate)
o Afti>t·-t::1v r::1<:h f1 ,n.., (Ri,f"r,e,,- t::w r::i<:h fin.ht - l n,rn.m,:, t::i vi><:I

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• After-tax cash tlow (Before-tax cash flow - Income taxes)
These elements are usually arranged to form an aftel'-tax cash flow table. This is illustrated by Example 12-6.

EXAMPLE 12-6
A profitable company buys $25,000 of equipment that qualifies for 100% bonus depreciation. The equipment is
expected to save $8000 per year over its 5-year life, wh en it will be sold for $6000.
(a) What is the before-tax present worth and rate of rerurn? Use a MARR of 15%.
(b) What is the after-tax present worth and rate of return? The after-tax ARR is usually lower, but the same 15%
is used so that the impact of taxes can be dearly seen.

TABLE SOLUTION TO PART a

The first step is to compute the before-tax cash flows.
Year Before- x Cash F ow

0 - $2.5.000
1 8.000
2 8.000
3 8.000
4 8.000
8,000
5 {
6,000

Solve for the before-tax present worth:

PW = - 25,000 8000(P/ A, 15%,5) + 6000 P/ F, 15%, 5)

= - 25,000 8000(3.352) + 6000(.4972) = $4799
Solve for the before-tax rate of return:

At i = 20%,PW = - 25,000 + 8000 P/ A 20%, 5 , + 6000(PJF, 20% . 5)

= - 25,000 + 8000 2.991) + 6000 .4019) = 1339.4

At i = 25%, PW = - 25 000 + 8000 P/ A 25% 5 , + 6000(PJF, 25%, 5

= - -5,000 + 8000 2.689) + 6000 .3277} = - 1521.8
1.339.4 - 0 )
IRRBT = 20% + 5% ( 1339.4 _ ( _ 1521 _8) = 0.223 = 22.3%

5-BUITON SOLUTION TO PART a

A B C D E F G H
1 Problem i 11 PMT PV FV Solve for Answer
2 Exp.12-6 15% 5 8000 6000 PV 29,800
3 -25,000 PV $4,800
4
5 5 8000 -25,000 6000 RATE 22.2%

TABLE SOLUTION TO PART b

For an after-tax present wmth, set up an after-tax cash flow table (Tab]e 12-2). The first element is the before-tax cash
flows (BTCF). The depreciation schedule for the equipment is the 100% bonus depreciation.

Bonus depreciation = $25 000 in Year 1

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The $2.5,000 in bonus depreciation is greater than year l's $8000 BTCF. The -$17,000 (= 8000 - 25,000) in taxable
income from this equipment will result in tax savings for the fi11n as a whole. At a 21 % tax rate this will save the firm
$3570 in taxes-which is shown as a positive cash flow in column d.
The Jast row in Table 12-1 shows the $6000 salvage value as a positive cash flow. It is taxable as recaptured
depreciation, since the equipment was depreciated to a book value of $0.

Table 12.-2 Afte~ Tax Cash Flow Tobie for Example 12- 6
(c} (dl (e )
(a) lb) Taxable 21 % Aher-Tax
Before-Tax Bonus Income Income Taxes Cash Flow
Year Cash Flow Dep~eciation (a)-{ I>) - 0 .2 1 (c) (a,) +(d)

0 - 25,000 -$25000
t 8.000 $2-5,000 -$17,000 3570 11 ,570
2 8.000 0 8,000 -1680 6,320
3 8.000 0 8000 -1680 6,320
4 8000 0 8,000 -1680 6,320
{ 8 000 0 8,000 -1680 { 6,320
5
6000 6,000 -!260 4 740

SPREADSHEET SOLUTION TO P:ART b

We now use the after-tax cash flows to find the after-tax present worth and IRR.

A B
1 ARR 15%
2 Year Aner-Tax Cash Flow
3 0 -$25,000
4 1 11,570
5 2 6,310
6 3 6,310
7 4 6,320
8 5 11,060
9 PV $3,107 =B3+ PV(B1,B4:B8)
10 IRR 20.34% =IRR(B3:B8)

The after-tax present worth is $3107 and the rate of return is 20.3%. This is a decrease in both present worth and
rate of return from the before-tax results.

Per the Tax Cuts and Jobs Act, 100% bonus depreciation is scheduled to be phased out after five years (2023), at which
time bonus depreciation wiU apply to only a portion of the investment. The balance of the depreciation will be governed
by MACRS. This scenario is demonstrated in Examp]e 12-7.

EXAMPLE 12-7
Repeat Example 12.-6 using 40% bonus depreciation. The purchase p1ice was $25,000 with annual savings of $8000
over its 5-year Ufe, when it will be sold for $6000. What is the before-tax and after-tax rate of return?

SOLUTION
For an after-tax present wmth, set up an after-tax cash flow table (Table 12- 3). Bonus depreciation will be 0.40 x
25,000 = $10,000, leaving $15,000 to be depreciated using MACRS. So Year 1 depredation is $10,000 from bonus
depreciation, plus (0.20 x 15, 000 = ) $3000 MACRS depreciation. Depreciation for years 2-5 are from the ACRS
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The $2.5,000 in bonus depreciation is greater than year l's $8000 BTCF. The -$17,000 (= 8000 - 25,000) in taxable
income from this equipment will result in tax savings for the fi11n as a whole. At a 21 % tax rate this will save the firm
$3570 in taxes-which is shown as a positive cash flow in column d.
The Jast row in Table 12-1 shows the $6000 salvage value as a positive cash flow. It is taxable as recaptured
depreciation, since the equipment was depreciated to a book value of $0.

Table 12.-2 Afte~ Tax Cash Flow Tobie for Example 12- 6
(c} (dl (e )
(a) lb) Taxable 21 % Aher-Tax
Before-Tax Bonus Income Income Taxes Cash Flow
Year Cash Flow Dep~eciation (a)-{ I>) - 0 .2 1 (c) (a,) +(d)

0 - 25,000 -$25000
t 8.000 $2-5,000 -$17,000 3570 11 ,570
2 8.000 0 8,000 -1680 6,320
3 8.000 0 8000 -1680 6,320
4 8000 0 8,000 -1680 6,320
{ 8 000 0 8,000 -1680 { 6,320
5
6000 6,000 -!260 4 740

SPREADSHEET SOLUTION TO P:ART b

We now use the after-tax cash flows to find the after-tax present worth and IRR.

A B
1 ARR 15%
2 Year Aner-Tax Cash Flow
3 0 -$25,000
4 1 11,570
5 2 6,310
6 3 6,310
7 4 6,320
8 5 11,060
9 PV $3,107 =B3+ PV(B1,B4:B8)
10 IRR 20.34% =IRR(B3:B8)

The after-tax present worth is $3107 and the rate of return is 20.3%. This is a decrease in both present worth and
rate of return from the before-tax results.

Per the Tax Cuts and Jobs Act, 100% bonus depreciation is scheduled to be phased out after five years (2023), at which
time bonus depreciation wiU apply to only a portion of the investment. The balance of the depreciation will be governed
by MACRS. This scenario is demonstrated in Examp]e 12-7.

EXAMPLE 12-7
Repeat Example 12.-6 using 40% bonus depreciation. The purchase p1ice was $25,000 with annual savings of $8000
over its 5-year Ufe, when it will be sold for $6000. What is the before-tax and after-tax rate of return?

SOLUTION
For an after-tax present wmth, set up an after-tax cash flow table (Table 12- 3). Bonus depreciation will be 0.40 x
25,000 = $10,000, leaving $15,000 to be depreciated using MACRS. So Year 1 depredation is $10,000 from bonus
depreciation, plus (0.20 x 15, 000 = ) $3000 MACRS depreciation. Depreciation for years 2-5 are from the ACRS
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U·t:plt:Ll<ilUUII, p ru:, \ U.LU ·" J. J, uuu - J ,.l;)\J\JU' !VJ.1"1.\..,1\..:) ut:plt:Ll<ilUU ll. Ut:JHt:L!clUUU lUl yt:c11 :, ,:_-._) cl!t: UUIJ.l Ult: 1Vl.t1.\..,I\..:)

depreciation table. Note that the equipment is sold before it is fully depreciated, so the final year depreciation is a half
year's. The book value at the end of Year 5 is then $1728, leaving recaptured depreciation (a taxable gain) of (6,000 -
1728 = ) $4272.
The federal income tax rate is 21 %, so taxes are 21% of taxable income. The recaptured depreciation is taxed as
regular income. The after-tax cash flow equals the before-tax cash flow ( column a) minus income taxes (column d).

Tobie 12-3 After-Tux Cash Flow Tub le for Example 12- 7

(c} (d) (e )
(a) Taxable 21 % After-Tax
Before-Tax (b} Income Income Taxes Cash Flow
Year Cash Flow Depreciation (a)-( b) - 0 .21 (c) (a}+(d l

0 - 25 000 -$25,000
t 8,000 13,000 -$5000 $!050 9,050
2 8,000 4,800 3200 -672 7,328
3 8,000 2 880 5120 - 1075 6,9;25
4 8,000 1.728 6272 -1317 6,683
{ 8,000 864,tc 7 136 - 1499 { 6,501
5
6,000 BV=l 728 4272 -897 5,103
The $864 in year 5 depreciation is based on daimi ng only 112 of the MA CRS depreciation in the year of sale. As shown in Example 11- 9, O"Ai, 50%,
or lOO"Ai of the fin al year depreciatimi can be claimed and the total taxable income in that year does not change.

We now use the cash flows to find the before-tax and after-tax IRR.

A B C
1 Year BTCF ATCF
2 0 -$25,000 -$25,.000
3 1 8,000 9,050
4 2 8,000 7,328
5 3 8,000 6,925
6 4 8,000 6,683
7 5 14,000 11,604
8 IRR 22.2% 19.1%

The rnx impact is to lower the internal rate of !"€turn from 22.2% to 19.1%.

Investment Tax Credit

Another tax policy technique used historicaUy in the U.S. to promote capital investments is the investment. tax credit
(ITC). Under the ITC, businesses are able to deduct a percentage of the purchase price of equipment .as a tax credit.
Depending on the provisions of the ITC ]aw in effect, this credit might be subtracted from the asset's basis for
depreciation, or perhaps not. In !"€Cent years investment tax credits have only been allowed in some specialized cases such
as historic building preservation and in the development of alternate energy sources. The genera] ITC for all assets may be
alfowed at some future time.

THE AFTER-TAX RATE OF RETURN

After-Tax Rate of Return with 100% Bonus Depredation Can Equal Before-Tax Rate
In practice, firms pay taxes qua1terly, not annually, and thus dep1"€dation is not calculated at the end of Year 1. Rather, it
can be t"€poned at Month 3, much closer to the beginning of the year than the end. As a result it can be more accurate to
assume that Year 1 depreciation is recorded in Year 0. This convention would increase a proj ect's after-tax rate of !"€tum
to equal Hs before-tax rate of return, as shown in Example 12-8. This example is shown for illustration purposes- we
assume the end-of-vear convention for depreciation elsewhere in the text.
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~ These pmbJems can be solved by hand, but most wiH be solved much more easily with a spreadsheet.

Corporate Taxes
12- Prom the perspective of taxes paid, describe the difference between capital asset costs and other costs-of-operation that are
1 expensed.
12- {a) If permitted to choose between depreciating a cost over sever-al years versus expensing .it in a single year, which would you
2 choose for your company? What factors mjght come into play in your recommendation?
G (b) H ims can reduce the taxes they pay in the .S. by setting internal transfer prices so the "profit" is earned in countries with
low tax rates or by selling themselves to an internation al finn. What are the ethical pros and cons o f these practices?
12- Earth Powered Oil Company has purchased green engineering technology equip ment for aJgae farms that turn sunlight into
3 automotive biofuel. Two sets of equi pment, each costing $200,000,. are needed. One set is being depreciated using MACRS
(9 depredation and the oth er is being depreciated with bonus depredation with z.emsalvage value . Assume the company pays taxes
annually and the tax rate is constant. Does the firm save more on income taxes with eitller one of th e ,equipment sets? If so,. wh.ich
one?
12- Compute income taxes owed for a firm with the following data:
4
I Gross income fro m sales $ 20 miJUon
Accumulated b usiness expenses $ 5.5 million
Depredation charges on assets $ 3.5 mill.ion

12- A firm's annual revenues are $850,000. Its expenses for the year are $615,000, and it clai.ms $135,000 in depreciation expenses.
5 What does it pay in laxes, and what is its after-tax income?

12- A major indu.striaUzed state has a state corporate tax rate of 9.6% of taxable income. If a corporation has a state taxable income of
6 $275,000, what is the total state and federal income lax it mu.st pay? Also, compute its combined incremental sta te and federal
I income tax rate.
12- A company wants to set up a new office in a counny where the corporate tax rate is: 15% of fi rst $50,000 profits, 25% of next
7 $25,000, 34% of next $25,000, and 39% of everything over $100,000. Executives es timate that they wm have gross revenues of
$500,000,. total costs of $300,000, $30,000 in allowable tax deductions, and a one-time business start-up c11edjt of $8000. vVhat is
taxable income for the firs t year, and how much should the company expect to pay in taxes?
12- To increase its market share, Sole Brother Inc.. decided to bonow $50,000 for more advertising for its shoe retaH Hn e. The loan is
8 to be paid in four equal annua.l paymen ts with 15% interest. The loan is d iscounted 12 points. The first 6 "points" a.re an additional
I interest charge of 6% of the loan, deducted immediately from what is received from the $50,000 .loan. Another 6 points or $3000
of additional interest is deducted as fo ur $750 additional annual interest payments. What is th,e after-tax in terest rate on this loan,
if the flrm's combined tax rate is 28%?
12- Concepcion Industries paid $308,.000 in federal taxes last year. If business expenses and depreciation cha.rges were $345,000, what
9 were their gross sales for the year?

Straight-Line Depreciation
12- A salad oil bottling plant can either buy caps for the glass bottles at 5¢ each or install $500,000 worth of plastic mold ing
10 equipment an d manufactu re the caps at the plant. The manufacturing engineer estimates the material, labor, and other costs would
I be 3.t per cap.
,(a) If 11 million caps per year are needed and the molding equipment is installed, what is the payback period?
{b) The plastic molding eq uipme nt would be depreciated by straight-line depreciation using a 6-year useful life and no salvage
value. Assum ing a combined 26% income tax rate, what is the after-tax payback period, and what is the after-tax rate of
return?
12- A computer-controlled mining machine will cost Ajax. Manufacturi ng $65,000 to purchase plus $4700 to install
11 {a) If the machine wo uld have a salvage val ue of $6600 at EOY 20, how much could Ajax charge annually to depredation of thi.s
equipment? Ajax uses straight-line depredation.
{b) What is the book va.lue of the machine at EOY 3?
•(c), Ajax Manufacturing earns a net profit before tax (also called a taxabl.e income) o f $28,800,000. How much tax would Ajax
owe for this yea.r?

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Contributed .by Paul R. McCright, University of South Florida

12-- The effective combJned tax rate in a firm is 28%. An outlay of $2 mU]jon for certain new assets is under consideration. Over the
12 next 9 yea.rs, these assets wiJJ be. responsible for annual receipts of $650,000 and annual disbursements (other than for income.
O taxes) of $225,000. After this time., they wiJJ be. used only for stand-by purposes with no future excess of receipts over
disbursements.
•(a) What is the prospective rate of return before income taxes?
,(b) What is the prospective rate of return after taxes if strajght-- 1.ine. depreciation can be used to write off these assets for tax
purposes in 9 yea.rs?
(c), What is the prospective rate of return after taxes if it is assumed that these assets must be written off for tax purposes over the
next 2.0 yea.rs, using straight-line depreciation?
12-- A project using passive heating/cooling desi gn concepts to reduce energy costs req uires an investment of $125,000 in equipment
13 (straight-line depreciation with a 10--year depreciable life and $0 salvage value), and $30,000 in labor (not depreciable). At the. end
(9 of 10 years, the project will be terminated . Assuming a combined tax ra te of 26% and an e.r-tax MARR of 15%, determine. the
project's after-tax present worth.
12-- Florida Constmction Bquipment Renta.ls {FCER) purchases a ne.w 10,000--pound-rated crane for rental to its customers. This crane
14 costs $1,125,000 and is expected to last for 25 years, at which time it will have an expected salvage va]ue of $147,000. FCER
I eams $195,000 before-tax cash flow each year in rental income. from this crane, and its totaJ taxable income each year is between
$10M and $15M. If FCER uses straight-line. depl'e.ciation and a MARR of 15%, what is the presen t worth of the after-tax cash
flow for this eq uipment? Should the company invest in this crane? Contributed by Paul R. McCright, University of South Florida
12-- A finn manufactures padded shipping bags. A ca.rd board carton should contain 100 bags, but machfoe operators fill the cardboard
15 cartons bye.ye, so a carton may rnntain anywhel'e from 98 to 123 bags (average= 105.5 bags). Each padded bag costs $0.03.
anagement realizes that they are g.iving away 5 1/2% of their output by overfilling the cartons. One sol ution is to automate th,e.
fiUing of shipping cartons. This should reduce t11e average quantity of bags per carton to 100.3, with almost no cartons containing
fewer than 100 bags.
The equjpment would cost $18,600 and straight-line depreciation with a 10--year depreciable life and a $3600 salvage. value would
be. used. T he equipment costs $16,000 annuaUy to operate. 200,000 cartons wiU be HI.led each year. This large. profitable
corporation has a 28% combined federal~plus-state increme.nta.1 tax rate . Assume a. 10--year study period for the analysis and an
an e.r-tax MARR of 15%.
Compute:
,(a) The after-tax present worth
,(b) The after-tax internal rate of return
•(c), The after-tax simp le payback period
12-- ACDC Company is considering the installation of a new machine that costs $150,000. The machine is ,expected to lead to net
16 income of $44,000 per year for the next 5 years. Using straight-line. depreciation, $0 salvage va.l ue., and an effective income tax
rate. of 23%, determine the after-tax rate of return for tMs investmen t. If th,e. company's after-tax MARR rate is 12%, would this be
a good investment or not?
Contributed by Mukasa Ssemakula, Wayne State University
12-- An old duplex was bought for $200,000 cash. Both sides were rented for $2500 pe.r month . T he. totaJ annual expenses for prope1ty
17 taxes, repairs, gardening, and so forth are estimated at $200 per month. For tax purposes, snaight--1.ine depreciation over a 20--year
remaining life with no salvage value is used. Of the total $200,000 cost of the property $50,000 is th,e. value of the lot. Assume
38% incremental income tax bracket (combined state and federal taxes) applies th.roughout the 20 years.
If the property is held for 20 years, what after-tax rate of retum can be expected?
(a) Assume the building and the lot can be sold for the lot's $50,000 estimated vaJue..
,(b) A more optimistic estimate of the fu ture value of the building and the lot .is that the prope·rty can be sold for $150,000 at the
end of 20 years.

Declining Balance Depreciation

12-- A firm is rnnsideri.ng the following investment project:
18
I

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Before-Tax Ca sh IFlow
Year (thousands)

0 -$1000
500
2 340
3 244
4 100
5 roo
125 Salvage value }
The project has a 5-year usefuJ ]ife with a $1 25,000 saJvage value, as shown . Double declining balance depreciation will be used,
assumjng the $125,00 0 salvage val ue. The combined income tax rate is 24%. If the finn requires a 10% after-tax rate of return,
should the project be underta.~en?
12- The Shellout Corp . owns a piece of petroleum driUing equipment that costs $300,000 and will be depreciated over 10 years by
19 doub le declining balance depreciation. There is a combined 30% tax rate. Shellout will lease the equipment to others and each
year receive $165,000 in rent. At the end of 5 years, the firm will sell the equipment fo r $80,000. What is the after-tax rate of
return Shellout ,,riJJ receive from this equipment investment?
12- An automaker is buying some special tools fo r $100,000. Th e too]s are being depreciated by doub]e declining balance
20 depreciation using a 4-year depreciable life and a $6250 sa]vage va]ue. It is expected the tools will actually be kept in service for 6
I years and then sold for $6250. The before-tax benefit of owning the tools is as follows:

Year Befor-e-Tax Cash Flow

1 $30,000
2 30,000
3 35,000
4 40,000
5 10,000
6 10,000
6,250 Selling price

Compute the after-tax rate of return for this investment situation, assuming a 30% incremental tax rate.
12- Th.is is the continuation of Probl,em 12-20. Instead of paying $100,000 cash for the tools, the corporation wilJ pay $20,000 now
21 and borrow the• remaining $80,000. The depreciation schedule will remain unchanged. The loan wilJ be repaid by 4 equal end-of-
year payments of $25,240.
Prepare an expanded cash f1ow table that takes into account both the speda] tools and the loan.
(a) Compute the after-tax rate of return for the tools, taking into account the $80,000 loan.
(b) Explain why the rate of retum obtained in part (a) is different from the rate of return obtained in Problem 12-20.
12- A fin n may invest in equipment that will be depreciated by double declining balance depreciatio n with conversion to straight-line
22 depreciation in year 5. For depredation purposes a $700,000 salvage value at the end of 6 years is assumed. But the actual value is
I thought to be $1,000,000, and it is tMs sum that 1s shown in the before~tax cash flow.

Year Before-Tax Cash Flow (in $1000)

0 -$12,000
1 1,727
2 2,414
3 2,872
4 3,177
5 3,358
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~ u , u....n...,

6 1,997
1,000 Salvage value

If the £inn wants a 9% after-tax rate of return and its combined incremental income tax rate is 24%, dete1mjne by annual cash flow
anaJysis whether the in vestme nt is desirable.

Bonus Depredation
Assume all bonus depreciatJon occurs in Year 1 un]ess otherwise stated.
12- A flrm has invested $60,000 in mach in ery wi th a 5-year useful life. Th,e machinery will hav,e no salvage value as the cost to
23 remove it will equal its scrap value. The uni orm annual benefits from the machinery are $15,000 . For a combined 45% income
tax rate, and 100% bonus depredation, compute the after-tax rate of return.
12- A farmer bought a new harvester for $120,000. The harvester 's operating expenses averaged $10,000 per year but the ha1vester
24 saved $40,000 per year in labor costs. 1t was depreciated over a life of 5 years using the 100% bonus depreciation method,
I assuming a salvage value of $30,000. The farmer sold the harvester for only $10,000 at the end of the fifth year. Given an income
tax rate of 30% and a MARR rate of 5% pe.r yea1~ determine the after-tax net present worth of this investment. Contributed by
Mukasa Ssemakula, Wayne State Universii:y
12- A £inn has invested $400,000 in car-washing equipment. They will depreciate the equipment by 60% bonus depreciation with the
25 balance using 5-year MACRS, assuming a $50,000 saJvage value at the end of the 5-year useful life . The flrm is expected to have
CD a before-tax cash flow, after meeting aU expenses of operation (except depreciation), of $165,000 per year. The firm's combined
corporate tax rate is 28%.
(a) If the projected income is con"ect, and the equipment can be sold fo r $100,.000 at the end of 5 years what after-tax rate of
return would the corporation receive from this venture?
(b) Summarize the environmental impact of commercial car washing. Include how wash water drainage is d irected, how
discharge sources a11e treated (or not), the impacts of sediment, detergents, waxes,. and heavy metals, aod local/state
po lkies/practices.
12- A mjnin g corporation purchased $120,000 of production mach in ery and deprecia~ed it using 40% bonus depredation with the
26 balance using 5-year MACRS depreciation, a 5-year depreciable life, and zero salvage vaJue. The corporation is a profitable one
I that has a 22% combined inc1"e mental tax rate.
At the end of 5 years the mining company changed its method of operation and sold the production machinery for $40,000.
During the 5 years the machinery was used, it reduc,ed m ine operating costs by $32,000 a year, before taxes. If th.e company
ARR is 12% after taxes, was th e investment in the machinery a satisfactory one?
12- Zeon, a large, profitable corporation, is considering adding some automatic equipment to its production facilities. An investment
27 of $120,000 will produce an annual benefit of $40,000. If the film uses 60% bonus depreciation with the balance using 7-year
A:CRS depredation, an 8-year useful life, and $12,0 00 salvage value, will it obtain the desired 12% after-tax rate of return?
Assume that the equipment can be sold for its $12,000 salvage val ue at the end of the 8 years . Also assume a 28% income tax rate
for state and federal taxes combined.

MACRS Depreciation
12- A special power tool for plastic products costs $400,000 and ha.s a 4-year us,eful life, no salvage value, and a 2-year before-tax
28 payback period. Ass ume uniform ann ual end-of-year benefits.
I •(a) Compute the befo1"e-tax rate of 1".etu.rn.
,(b) Compute the after-tax rate of return, based on ACRS dep1"eciation an d a 24% combined corporate income tax rate.

12- ,(a) The BVM Corp., a construction company, purchased a used hyb1id electric pickup truck for $30,000 and used MACRS
29 depreciation in the income tax return. Du1ing the time the company had the nuck, they estimated that it saved $9500 a year.
CD At the end of 4 years, BVM sold the truck for $9000. The combined federal and state income tax rate for BV is 28% .
Compute the after-tax rate of return for the truck.
(b) Hybrid electric vehicles (HEVs), such as the truck purchased by BVM Corp., are recognized for their fuel effidency and
earth-friendliness. However, 110 major technology is without negative environmental impacts. Summarize the key
environmentaJ issues, such as gJ"e•enhouse emissions in use, life-cycle impacts of battery sources (such as Iithium-ion and
nickel metal hydride), vehicle production impacts, and other life-cycle impacts.
12- A chemica.1 company bough1 a small vessel for $550,000; it is to be depreciated by 10-year MACRS . When requi.rements changed
30 suddenly, the chemical company leased the vessel to an oil company fo r 6 years at $100,000 per year. The lease aJso provided tha t
I the oil company could buy the vessel at the end of 6 years for $350,000. At the eod of the 6 years, the oil company exercised its
option and bought the vessel. T he chem ical company has a 24% com bined incremental tax rate. Compute its after-tax ra te of

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retum on the vessel.

12- Xon, a small oi.l e,q uipment company, purchased a new petroleum drHling rig for $2,000,000. Xon wiH deprecia te it using MACRS
31 depreciation. The driUing rig has been leased to a firm, which will pay Xon $750,000 per year fo r 8 years. After 8 years the

l3 drilUng rig win belong to the finn. Xon has a 28% combined incremental tax rate and a 20% after-tax MARR
•(a) Does the investment appear to be satisfactory?
,(b) Some claim that the coa.1 and/or oil induso·ies are inherently unsustainable and harmful to the environment. Develop a short
position summary to support and chaUenge this perspective.
12- The profitable Palmer Golf Cart Corp, is considering investing $300,000 in special tools for some of the plastic golf can
3.2 components. The present golf cart model wrn continue to be manufacrured and sold for 5 yea.rs, after which a new cart design will
I be needed, together with a different set of specia.l tools.
The saving in manufacturing costs, owing to the special tools, is estim ated to be $150,000 per year for 5 years, Assume ACRS
depreciation for the spedal tools and a 27% combined income tax rate.
{a) What is th.e after-tax payback period for this inves tment?
•(b) If the company wants a. 12% after-tax rate of retum,. is this a. desirable investment?
12- Granny's Butter and Egg Business is such that she pays an effective tax rate of 25%. Granny is considering the purchase of a new
33 Turbo Churn for $25,000. This churn is a special handling device for food manufacture and has an estim ated life of 4 years and a
salvage value of $5000. The new churn is expected to increase net income by $8000 per yea:r for ea.c h of the 4 years of use. H
Granny works with an after-tax MARR of 10% and uses 3-year MACRS depreciation, should she buy the chum?
12- An engineer is working on the layout of a new research and experi.mentation facility. Two plant operators wiU be required. If,
34 however~ an additional $100,000 of instrumentation and remote controls were added, the plant could be run by a single operator.
I The total before-tax cost of each plant operator is projected to be $35,000 per year. The i11so11mentation and controls will be
depreciated by means of the modified a.ccel.erated cost recovery system {MACRS).
If thJs corporation (22% combined corporate tax rate) invests in the additionaJ inso11rnentation and controls, how long wiU it take
for the after-tax benefits to eq ual the $100,0DO cost? In other words, what 1s the after-tax payback period?
12- A corporation with a 27% combined income tax rate is considering the folJowing investment in research equipment.
35 Year Before-Tax Cash Flow
0 -$7,500,000
1 650,000
2 950,000
3 2,750,000
4 1,90D,OOO
5 800,000
6 450,000

Prepare an after-tax cash flow table assuming MACRS depreciation.

•(a) What is the before-tax rate of return?
,(b) What is the after-tax rate of return?
1.2- Specialty Maclhining, Inc. bought a new m ulti-turret turning center for $250,000. The machjne generated new revenue of $80,000
36 per year. Operating costs fo r th,e machjne averaged $10,000 per year. Following IRS regulatio ns, the machine was depreciated
I using the MACRS metho d, with a recovery period of 7 years. The center was sold for $75,000 after 5 years of service. The
company uses an after-tax MARR rate of 12% and is in the 23% tax bracket. Debermine the after-tax net present worth of this
asset over the 5-year service per1od . Contributed by Mukasa Ssemakula, Wayne State University
12- ABC Co. is contemplating an $18,000 investment in a methane gas generator. They estimate gross i.ncome will be $4500 the firs t
37 year and increase by $500 each year over the next 10 years. Expenses of $300 the first year would increase by $250 ea.c h year over
I the next 10 years. ABC will depreciate th.e gene:rator by MACRS depredation, assuming a 7-year property class. A 10-year-old
methane generator has no market val ue. The comb111ed income tax rate is 31% . (Remember that recaptured depreciation is taxed at
the same 31% rate .)
,(a) Construct the after-tax cash flow for the 10-year project life.
,(b) Determfoe the after-tax rate of return on this investment ABC Co. th.in ks it should be at least 8%.
,(c), If ABC Co. couJd sell the generator for $10,0DO at the end of the fifth yea1~ what would the rate of return be?
12- Fleet Fleet renta.l car company purchased 10 new cars for a total cos t of $180,000. The cars generated i.ncome of $150,000 per
38 year an d incun-ed operating expenses of $60,000 per year. The company uses MACRS depreciation and its margin aJ tax rate is
I 28% (Note: Per IRS regulations, cars have a dass life of 5 years). The 10 cars were sold at the end of the third year for a total of
$75,000. Assuming a MARR of 10% and using NPW, determine if this was a good investment on an after-tax basis. Contributed
>h~, '4 11'• • J~....... .-. (' ..., ...,.,.,.,.,..,, .~J.-. lA I.-.~, ..... .-.. C"..-,...;.,,.., 1 r..... :............... :,....

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by Mukasa Ssemakula, Wayne State Unjversity
12- id-Amelica Shipping is considering purchasing a new barge for use on its Ohio River routes . The new barge wm cost $13.2
39 miUion and is expected to generate an income of $7.5 million the fi.rst year (growing $1M each year),. with additional expenses of
$2.6 miUion the first year (growing $400,000 per year) . If Mid-America uses ACRS, .is in the 26% tax bracket, and has a
ARR of 12%, what is the present worth of the first 4 years of after-tax cash flows from this barge? Would you recommend that
id-Ame1ica purchase this barge? Does yom answer change at 5 or 6 or 7 or ... years? Contributed by Paul R. McCright,
University of South Florida
12- An investor bought a racehorse for $1 rnimon. The horse's average winnings were $700,.000 per year and expenses averaged
40 $200,000 per year. The horse was retired after 3 years, at which ti.me it was sold to a breeder for $175,000. Assuming MACRS
C, depredation, a class life of 3 years, and an income tax rate of 28%, determine the investor's after-tax rate of return on this
investment. Contributed by Mukasa Ssemakula, Wayne State University
12- Tampa Electrk Company (TECO) is planning a major upgrade in its computerized demand management system. In order to
41 accommodate this upgrade,. a building will be constructed on land already owned by the company. The buiJding is estimated to
cost $1. BM and will be opened in August of this year. The computer equipment for the building win cost $2.75 , and all office
equipment wm cost $225,000. Annual expenses for operating this facili ty (labor, materials, insurance, energy, etc.) are expected to
be $325,000 for the rest of this year. Use of the new demand management system is expected to decrease fuel and other costs for
tile company by $L8M this year. If the company expects to ,eam 9% on its investments, is in the 23% tax bracket, and uses a 20~
year planning horizon, determine the estimated after-tax cash fJow from this project for this year. Contributed by Paul R.
McCright, University of South Florida

Solving for Unknowns

12- A store owner, Jing Lang, believes his business has suffered from th,e lac k of adeq uate customer parking space. He may buy an old
42 building and lot next to his store. He would demolish the old building and make off-street parking on th,e Jot. Jing estimates that
C, tile new parking would increase h.is before-income-tax profit by $7000 per year. It would cost $2500 to demolish the o]d building,
r. Lang 's accountant advised that both costs (the property and demolisbing the old building) would be co ns.idered to comprise
tile tola] va.lue of the land for tax purp oses, and it would not be depreciabJe.
r. Lang wouJd spend an additional $3000 rigbt away to put a ligbt gravel surface on the .lot. He beHeves this may be charged as
an operating expense immediately. His combined state and federal incremental income tax rate will average 28%. If Jing wants a
15% after-tax rate of return from this project, bow mucb could he pay to purchase the adjoining land with the old building?
Assume that the analysis pe.riod is 10 years and that the parking lot could always be sold to recover the costs of buying the
property and demolishing the old building.
12- The management of a plivate hospitaJ is considering automating some back office functions. Th.is would replace five persmmel
43 that cunently cover three shifts per day, 365 days per year. Each person eams $35,000 per year. Company-paid benefits and
overtiead are 45% of wages . Money costs 8% after income taxes. Combined federal and state income taxes are 28%. Annual
property taxes and maintenance are 2 1/2 and 4% of investment, respectively. Depreciation is lS~year straight line. Disregarding
inflation, bow large an investm,ent in the automation project can be economically justified?
12- A house and lot are for sale fo r $155,000. It is estimated that $45,000 is the land's value and $110,000 is the value of the house.
44 The net rental income would be $12,000 per year after taking all expenses, except depredation, into acco unt. The house would be
C, depreciated by straigbt-Jine depredation using a 27.5-year depreciable ]ife and zero salvage value.
ary Silva, the prospective purchase1~ wants a 10% after-tax rate of return on her .investment after con£idering both annuaJ
income taxes and a capital gain when she sells the house and lot. At. what price would she have to sell the house at the end of 10
years to achieve her objective? Assume that Mary has an incremental income tax rate of 24% in each of the 10 years and a capital
gain rate of 20%.
12- A conn-actor has to cboos,e one of the following a.ltematives in perfmming earthmoving contracts:
45 A . Buy a heavy-duty trnc.k for $35,000. Salvage vaJue is expected to be $8000 at the end of the vehide's 7-year depreciable Ufe.
Maintenance is $2500 per year. Daily operating expenses a:re $200.
B. Hi.re a similar unit for $550 per day.
Based on a 10% after-tax rate of return, how many days per year must the truck be used to justify its purchase? Base your
caJculations on sna.ight-line depredation and a. 28% income tax rate.
12- A large profitable company, in the 28% combined federal/state tax bracket, is considering the purcbaf>e of a new piece of
46 equipment that will yield beneflts of $10,000 in Year 1, $15,000 in Year 2, $20,000 in Yea r 3, and $20,000 in Yea.r 4. The
C, equipment is to be depreciated using 5-year ACRS depreciation starting in the year of purchase (Year 0). It is expected that the
equipment will be sold at the end of Year 4 at 20% of its purchase price. What is the maximum equipment purchase price the
company can pay if its after-tax MARR is 10%?
12- The Able Corporation is considering the installation of a smaH electronic testing device for use in conjunction with a government
47 connc1ct the fi1m has just won . The testing device wm cost $20,000 and will have an estimated salvage value of $5000 in 5 yea.rs
when the government contract is finisbed. The flrm wiH depreciate the insnu ment by MACRS using 5 years as the dass l.ife.
Assume that Able pays 27% federal and sta te COIJJorate income taxes and uses 8% after-tax in eco nomic ana]ysis. What minimum
- ---- '1 - - - - --1 L- - -.l:~-i- _ ___ ,. o\'L t- _L .... -~ - L_.£ ___ J.--·-- !- ---1- _£ ,;.L_ r - •---- . ._ _ ? • • _ ....! .£• • -----'L. --~ - .... ... L _ - 1 ------ - ~- •--"-~ - .... ..l---~--""11

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may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.
equal annual benefit must Able obtain before taxes in each of the 5 years to j ustify purchasing the electronic testing devi ce?
12- A sa.les engineer has the following altematives to consider in touring hi.s sales territory.
48 A. Buy a 2-year old used car fo r $14,500. Salvage value is expected to be about $5000 after 3 more years. MaJntenance and
I insurance rnst is $1000 in the first year and increases at the rate of $500/year in subsequent years. Daily operating expenses
are $50/day.
B. Rent a similar car for $80/day.
Based on a 12% after-tax rate of retum, how many days per year must he use the car to justify its purchase? You may assume that
this sales engineer is in the 23% incremental tax bracket. Use MACRS depreciation.
12- For many firms,. environmentaJ regulation and oversight a.re converting external "sod a] costs" to internal "real. costs." TDE
49 Ind ustries is considering investing in equipment to reduce emissions. Without the investment th,ey expect to incur fines and fees of
C9 $750,000 per year. IDE uses a 28% combined tax rate, an after-tax MARR of 20%, and will depreciate such equipment as a 5-
year MACRS property.
,(a) Management has asked you to determine the maximum amount they should pay for equipment to eliminate these fines. Use a
6-year study period.
,(b) What argument would you add to the economic analysis to justify the in vestment?
•(c), If your manager dee.ides to purchase $1M in equipment, what level. of decreased fees would jus tify the investment? Use a 6-
year study peri.od.

Section 179, Bonus Depredation, and Tax Credits

12- Ch1istopher wants to add a solar photovoltaic system to his home. He plans to instaU a 2-kW system and has received a quote
50 fro m an instaUer who will instal] this unit for $19,750. The federal government wiJJ give hi.rn a tax credit of 30% of the cost, and
fD the state will give a 10% tax credit. State law requi.res the utiUty company to buy back aU excess power generated by the system.
Christopher's annua1 power biU is estimated to be $2000, and this will be eliminated by the solar system. Christopher expects to
receive a check from the power company fo r $600 each year for his excess pro duction. 1f the tax credjts are received at EOY 1 and
Ch1istopher receives a $2000 savings plus a $600 income at the end of each year, use present worth to determine if the system
pays for itself in 8 years. Assume that Christopher earns 3% on an investm ents. Contributed by Paul R. McCright, University of
South .Florida
12- Rework Pro blem 12-30 assuming that a $1,000,0 00 Section 179 deduction and a 60% bonus depredation deduction apply.
51
12- Rework Problem 12-31 assuming that a $1,000,000 Section 179 deduction applies along with 40% bonus depreciation.
5.2
I
12- Rework Problem 12-33 assuming that a 60% bonus depreciation applies.
53
12- Rework Pro bl.em 12-36 assuming that 40% bonus depredation applies.
54
I
12- Rework Problem 12-10 assuming that a 10% Investment Tax Credit (ITC) that does not reduce the dep reciable basis applies.
55
12- Rework Pro blem 12-12 assuming that a 10% Investment Tax Credit (ITC) that does not reduce the dep reciable basis applies.
5G
I
12- Rework Problem 12-25 assuming that a 10% Investment Tax Credit (ITC) that does reduce the depreciable basis applies.
57
12- Rework Pro blem 12-26 assuming that a 10% Investment Tax Credit (ITC) that does reduce the dep reciable basis applies.
58

I
Multip,le Alternatives
12- A smaU-business corporation is considering whether to replace some equipment in the plant. An analysis indicates there are fi ve
59 altematives in addition to the do-nothing option, Al t. A The alternatives have a 5-year useful life with no salvage value. Straight-
line depred ation would be used.

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Alternatives Cost (thousands) Before-Tux. Uniform Annual Benefits ,(thousands),

A $0 $0
B 25 8
C 10 5
D 5 2
E 15 5

The firm has a combined federal and state income tax rate of 26%. If the corporation expects a 8% after-tax rate of return for any
new investments, which alternative should be selected?
12- A corporatio n with $7 million in annual taxable income and no state tax is considering two a.ltematives:
60
0 Before-Tux Cash Flow ($1000)
Year Alt.1 Alt. 2
0 -$10,000 -$20,000
1-10 4,500 4, 00
11-20 0 4,500

Both alternatives will be depl'eciated by 40% bonus depreciation taken in year O plus 10-year MACRS depredation. Neither
altemative is to be replaced at the end of its useful life. If the corporation has a minimum attractive rate of return of 10% after
taxes, which alternative should it choose? Solve the probl em by:
,(a) Present worth analysis
,(b) Annual ca~ flow analysis
,(c), Rate of return analysis
,(d) Future worth ana.lysis
,(e), Benefit-cost ratio analysjs
12- If a firm's after-tax mjnimum attractive rate of return is 10% and jts combined incremental income tax rate is 28%, whidt
61 altemative should be s,elected? Use incremental JRR.

Alt. A Alt. B
Initial cost $11,000 $33,000
Uniform annual benefit 3,000 9,000
End-of-depl'edable~ life 2,000 3,000
sa]vage value
Depreciation method 40%bonus 40% bonus
plusMACRS plus MACRS
End-of-useful-Hfe 2,000 5,000
sa]vage value obtained
Depreciable life, in yea.rs 5 5
Useful life, in years 5 5

12- Use the after-tax IRR method to evaluate the following three alternatives using 60% bonus depredatio n in Year O and 3-year
6.2 ACRS, and offer a recommendation. The after-tax ARR is 25%, the proj ect life is 5 years, and the flrm has a combined
O incremental tax rate of 31%.

Alt. First Cost Annual Costs Salvage Value

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