Chapter 7 Depreciation and Taxes

Chapter 7 Depreciation and Taxes - 1 Depreciation and...

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Unformatted text preview: 1 Depreciation and Income Taxes Chapter 7 2 To evaluate engineering projects or alternatives using ATCFs we find the PW of the ATCFs using the after-tax MARR (or find the IRR of the ATCFs and compare it to the after-tax MARR). Why study Depreciation and Taxesnote the effect on cash flows Gross Income for year k (Revenues)- Cost of Goods Sold- O&M Expenses- Depreciation =Net Income Before Taxes for year k (NIBT k ) also called Taxable Income for year k (TI k )- Income Taxes =Net Income After Taxes for year k (NIAT k ) +Depreciation =After Tax Cash Flow for year k (ATCF k ) 3 Depreciation An accounting concept The decrease in value of properties over time Actual amount of depreciation is difficult to estimate until the property is retired from use Can begin to depreciate property after it is placed in service Depreciable assets:-are used for business or held to produce income-have a definite service life (longer than one year)-wear out, decay, get used up, become obsolete, or lose value from natural causes.-are not inventory, stock in trade, or investment property.-land is not depreciable 4 Depreciation Methods Classical Methods (before 1981, includes Straight Line (SL) , Declining Balance (DB), DB with Switchover to SL, and Units of Production) Accelerated Cost Recovery System (ACRS) between 1980 and 1986 Modified Accelerated Cost Recovery System (MACRS) after 1986. This method must be used for tax purposes but many firms use alternative methods for accounting purposes 5 Terminology Adjusted Cost Basis Basis, or Cost Basis (B) Book Value (BV) Market Value (MV) Recovery Period Recovery Rate Salvage Value (SV) Useful Life 6 Straight Line (SL) Depreciation Method d k = (B - SV N ) / N d k * = kd k for 1 k N BV k = B - d k * where N = depreciable life of the asset in years B = cost basis, including adjustments d k = annual depreciation deduction in year k (1 k N) BV k = book value at the end of year k SV N = salvage value at the end of year N d k * = cumulative depreciation through year k 7 Example 1 An asset has a cost basis of $2,500 and a 5-year depreciable life. The asset has no estimated salvage value. Calculate the annual depreciation amounts using the SL method. Example 2 An asset is purchased for $16,000. It has a useful life of 7 years and a salvage value of $2000. What is the SL depreciation schedule? 8 Declining Balance (DB) Depreciation Method Assumes that the annual cost of depreciation is a fixed percentage of the BV at the beginning of the year....
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Chapter 7 Depreciation and Taxes - 1 Depreciation and...

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