The Mellow Machine Company is considering the addition of a computerized lathe to its equipment inventory. The initial cost of the equipment is P600,000, and the lathe is expected to have a useful life of five years and no salvage value. The cost savings and increased capacity attributable to the machine are estimated to generate increases in the firm’s annual cash inflows (before considering depreciation) of P180,000. The machine will be depreciated as follows for tax purposes: Year Depreciation 1 P200,000 2 266,700 3 88,860 4 44,440 Mellow is currently in the 40 percent tax bracket. A 10
Depreciation Methods
The word "depreciation" is defined as an accounting method wherein the cost of tangible assets is spread over its useful life and it usually denotes how much of the assets value has been used up. The depreciation is usually considered as an operating expense. The main reason behind depreciation includes wear and tear of the assets, obsolescence etc.
Depreciation Accounting
In terms of accounting, with the passage of time the value of a fixed asset (like machinery, plants, furniture etc.) goes down over a specific period of time is known as depreciation. Now, the question comes in your mind, why the value of the fixed asset reduces over time.
The Mellow Machine Company is considering the addition of a computerized lathe to its equipment inventory. The initial cost of the equipment is P600,000, and the lathe is expected to have a useful life of five years and no salvage value. The cost savings and increased capacity attributable to the machine are estimated to generate increases in the firm’s annual
|
Year |
Depreciation |
|
1 |
P200,000 |
|
2 |
266,700 |
|
3 |
88,860 |
|
4 |
44,440 |
Mellow is currently in the 40 percent tax bracket. A 10 percent after-tax
The total present value of the depreciation tax shield is:
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