Question

A construction company is considering buying a piece of excavation equipment for $70,000 in cash, with a 5 year useful life and salvage value of $15,000. Maintenance will be $10,000 in the first year and increase 3% per year, the company has an MARR of 10%, and the effective tax rate is 30%. Assume that the company can write off depreciation (that is, these costs can be deducted from taxable income).

1.What is the book value of the asset after 3 years, assuming straight line depreciation?

2.Repeat part a but with double-declining balance depreciation.

3.Now use the switch-over (VDB) method for depreciation. In which year should you switch to straight-line depreciation?

4.Again assuming straight line depreciation, what annual revenue resulting from the equipment must the equipment generate to be a worthwhile investment?

5.Suppose revenues from the equipment are $50,000 per year. Calculate the NPV.

Answer 1

1)
Depreciation per year = ($70,000 - $15,000)/5	$ 11,000.00
Book Value after 3 years = $70,000 - (11000 x 3 )	$ 37,000.00
2)
Double decline balance Dep. = 1/5 x 2	40%
Year	Beginng Bal.	Dep.	Ending Bal
1	70000	28000	42000
2	42000	16800	25200
3	25200	10080	15120
3) VDP
Year	Beginng Bal.	Dep.	Ending Bal
1	70000	$ 28,000.00	42000
2	42000	$ 16,800.00	25200
3	25200	$ 10,080.00	15120
4	15120	$      120.00	15000
5	15000	$             -	15000
Year 3 It only switches to Straight Line calculation when Depreciation Value, Straight Line is higher than Depreciation Value, DDB.