Principles of Managerial Finance

(Dana P.) #1

372 PART 3 Long-Term Investment Decisions


TABLE 8.6 Depreciation Expense for Proposed and Present
Machines for Powell Corporation

Applicable MACRS depreciation Depreciation
Cost percentages (from Table 3.2) [(1)(2)]
Year (1) (2) (3)

With proposed machine
1 $400,000 20% $ 80,000
2 400,000 32 128,000
3 400,000 19 76,000
4 400,000 12 48,000
5 400,000 12 48,000

6 400,000  (^5)   (^2)  (^0) , (^0)  (^0)  (^0) 
Totals 1

0

0

%$

4

0

0

,

0

0

0

With present machine
1 $240,000 12% (year-4 depreciation) $28,800
2 240,000 12 (year-5 depreciation) 28,800
3 240,000 5 (year-6 depreciation) 12,000
4 0
5 0
(^6)  (^0) 
Total $

6

9

,

6

0

0

a
aThe total $69,600 represents the book value of the present machine at the end of the third year, as calcu-
lated in the preceding example.
Because the present machine is at the end of the third year of its cost recovery at
the time the analysis is performed, it has only the final 3 years of depreciation
(as noted above) still applicable.



  1. As noted in Chapter 3, it takes n1 years to depreciate an n-year class asset under current tax law. Therefore,
    MACRS percentages are given for each of 6 years for use in depreciating an asset with a 5-year recovery period.

  2. It is important to recognize that although both machines will provide 5 years of use, the proposed new machine
    will be depreciated over the 6-year period, whereas the present machine, as noted in the preceding example, has been
    depreciated over 3 years and therefore has remaining only its final 3 years (years 4, 5, and 6) of depreciation (12%,
    12%, and 5%, respectively, under MACRS).


summing the purchase price of $380,000 and the installation costs of $20,000.
The proposed machine is to be depreciated under MACRS using a 5-year recov-
ery period.^10 The resulting depreciation on this machine for each of the 6 years,
as well as the remaining 3 years of depreciation (years 4, 5, and 6) on the present
machine, are calculated in Table 8.6.^11
The operating cash inflows in each year can be calculated by using the
income statement format shown in Table 8.7. Substituting the data from Tables
8.5 and 8.6 into this format and assuming a 40% tax rate, we get Table 8.8. It
demonstrates the calculation of operating cash inflows for each year for both the
proposed and the present machine. Because the proposed machine is depreciated
over 6 years, the analysis must be performed over the 6-year period to capture
fully the tax effect of its year-6 depreciation. The resulting operating cash inflows
are shown in the final row of Table 8.8 for each machine. The $8,000 year-6 cash
inflow for the proposed machine results solely from the tax benefit of its year-6
depreciation deduction.
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