Chapter 25, Problem 3AP

1.

To determine

Prepare a five-column table with the below that reports amount using the straight-line depreciation method for each of the six years:

1. a. Pretax income before depreciation,
2. b. Straight-line depreciation expense,
3. c. Taxable income,
4. d. Income taxes, and
5. e. Net cash flow.

Explanation of Solution

Cash flow:

Cash flow is the monetary consideration (return or income) received by the business for its long-term capital investment.

Straight-line depreciation method:

The depreciation method which assumes that the consumption of economic benefits of long-term asset could be distributed equally throughout the useful life of the asset, is referred to as straight-line method.

Prepare a five-column table that reports amounts using the straight-line depreciation for each of the six years as follows:

Years	(a)	(b)	(c)	(d)	(e)
	Income Before Depreciation	Straight-Line  Depreciation	Taxable Income	Income Taxes @ 40%	Net Cash Flows
			$\left(\text{a}-\text{b}\right)$	$\left(\text{c×40\%}\right)$	$\left(\text{a}-\text{d}\right)$
Year 1	66,000	9,000	57,000	22,800	43,200
Year 2	66,000	18,000	48,000	19,200	46,800
Year 3	66,000	18,000	48,000	19,200	46,800
Year 4	66,000	18,000	48,000	19,200	46,800
Year 5	66,000	18,000	48,000	19,200	46,800
Year 6	66,000	9,000	57,000	22,800	43,200

Table (1)

2.

To determine

Prepare a five-column table with the below that reports amount using the MACRS depreciation method for each of the six years:

1. a. Pretax income before depreciation,
2. b. MACRS depreciation expense,
3. c. Taxable income,
4. d. Income taxes, and
5. e. Net cash flow.

Explanation of Solution

Cash flow:

Cash flow is the monetary consideration (return or income) received by the business for its long-term capital investment.

Modified accelerated cost recovery system (MACRS):

This is a depreciation method permitted by Internal Revenue Service to be used for tax purposes because this method allows to record higher depreciation expense for certain years.

Prepare a five-column table that reports amounts using MACRS depreciation method for each of the six years as follows:

Years	(a)	(b)	(c)	(d)	(e)
	Income Before Depreciation	MACRS Depreciation	Taxable Income	Income Taxes @ 40%	Net Cash Flows
			$\left(\text{a}-\text{b}\right)$	$\left(\text{c×40\%}\right)$	$\left(\text{a}-\text{d}\right)$
Year 1	66,000	$18,000	48,000	19,200	46,800
Year 2	66,000	28,800	37,200	14,880	51,120
Year 3	66,000	17,280	48,720	19,488	46,512
Year 4	66,000	10,368	55,632	22,253	43,747
Year 5	66,000	10,368	55,632	22,253	43,747
Year 6	66,000	5,184	60,816	24,326	41,674

Table (2)

3.

To determine

Compute the net present value of the investment under straight-line depreciation method, using 10% discount rate.

Explanation of Solution

Net present value method:

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.

Compute the net present value of the investment under straight-line depreciation method, using 10% discount rate as follows:

Particulars	Cash flows Amount ($) (a)	PV Factor @ 10 % (b)	Present value $\left(\text{a}\times \text{b}\right)$
Net cash inflows:
Year 1	$43,200	0.9091	$39,273
Year 2	46,800	0.8264	38,676
Year 3	46,800	0.7513	35,161
Year 4	46,800	0.683	31,964
Year 5	46,800	0.6209	29,058
Year 6	43,200	0.5645	24,386
Total	$273,600		198,518
Less: Amount invested			90,000
Net present value			$108,518

Table (3)

Note:

• For the present value factors refer Table B.1 in appendix-B.

4.

To determine

Compute the net present value of the investment under MACRS depreciation method, using 10% discount rate.

Explanation of Solution

Net present value method:

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.

Compute the net present value of the investment under MACRS depreciation method, using 10% discount rate as follows:

Particulars	Cash flows Amount ($) (a)	PV Factor @ 10 % (b)	Present value$\left(\text{a}\times \text{b}\right)$
Net cash inflows:
Year 1	$46,800	0.9091	$  42,546
Year 2	51,120	0.8264	42,246
Year 3	46,512	0.7513	34,944
Year 4	43,747	0.683	29,879
Year 5	43,747	0.6209	27,163
Year 6	41,674	0.5645	23,525
Total	$273,600		200,000
Less: Amount invested			90,000
Net present value			$110,303

Table (4)

Note:

• For the present value factors refer Table B.1 in appendix-B.

5.

To determine

Explain the reason for the increase in net present value under MACRS depreciation method.

Explanation of Solution

Explain the reason for the increase in net present value under MACRS depreciation method as follows:

From the above explanation it is clear that the net present value under MACRS depreciation method is higher than the net present value under straight-line depreciation method. This is due to the larger cash flows of the asset’s life in the earlier years. Hence, the depreciation deductions are also larger under MACRS depreciation method and thus this result in a less income tax payments in the earlier years.