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Lilly Company is planning to buy a set of special tools for its grinding operation. The cost of the tools is $18,000. The tools have a three-year life and qualify for the use of the three-year MACRS. The tax rate is 40 percent; the cost of capital is 12 percent. Required: 1. Calculate the present value of the tax depreciation shield, assuming that straight-line depreciation with a half-year life is used. 2. Calculate the present value of the tax depreciation shield, assuming that MACRS is used. 3. What is the benefit to the company of using MACRS?

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Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663

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Chapter
Section
BuyFindarrow_forward

Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663
Chapter 19, Problem 18E
Textbook Problem
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Lilly Company is planning to buy a set of special tools for its grinding operation. The cost of the tools is $18,000. The tools have a three-year life and qualify for the use of the three-year MACRS. The tax rate is 40 percent; the cost of capital is 12 percent.

Required:

  1. 1. Calculate the present value of the tax depreciation shield, assuming that straight-line depreciation with a half-year life is used.
  2. 2. Calculate the present value of the tax depreciation shield, assuming that MACRS is used.
  3. 3. What is the benefit to the company of using MACRS?

1.

To determine

Calculate the present value of the after tax depreciation, assume that straight-line depreciation with a half-year life is used.

Explanation of Solution

Net present value method (NVP): Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is desired by the business based on the net income from the investment, and it is also called as the discounted cash flow method.

 Calculate the present value of the after tax depreciation, assume that straight-line depreciation with a half-year life is used:

YearAnnual deprecation (A) (1)Deprecation after tax (B)(A×40%)Discount factor @ 12% (C)

Present value

(B×C)

13,000$1,2000.893$1,072
26,000$2,4000.797$1,913
36,000$2,4000

2.

To determine

Calculate the present value of the after tax depreciation, assume that MACRS method is used.

3.

To determine

State the benefits that the company enjoys when using MACRS method of depreciation.

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Chapter 19 Solutions

Cornerstones of Cost Management (Cornerstones Series)
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