Question

In: Economics

You intended to buy new equipment for $2,000,000, you will depreciate it in value using MACRS...

You intended to buy new equipment for $2,000,000, you will depreciate it in value using MACRS depreciation for a 5-year property. The equipment will then be leased to a friend for $500,000 per year for 4 years. After 4 years, it will be sold to your friend for $700,000.

5-year MACRS schedule:

year 1 = 20%

year 2 = 32%

year 3 = 19.2%

year 4 = 11.52%

year 5 = 11.52%

year 6 = 5.76%

a) what is the book value of the equipment in year 3

b) what, if any, is the recaptured depreciation in year 4

c) is the tax rate is 40% what are the taxes paid in year 4 for the purchase and lease of the equipment

d) will you buy the equipment if it has a MARR of 12%

Expert Solution

What is the book value of the equipment in year 3

= Purchase cost - 3 years' depreciation

= 2000000 - (20 + 32 + 19.2) of purchase cost

= 2000000 - 71.2*2000000

= 2000000 - 1424000

= 576000 will be book value at the end of 3rd year

The recaptured depreciation in year 4

Book value at the end of 4th year

= Book value at the end of 3rd year - 4th year's depreciation

= 576000 - (2000000*11.52%)

= 576000 - 230400

= 345600

= Salvage value at the end of 4th year - Book value of equipment at the end of 4th year

= 700000 - 345600

= 354400 is gain

Tax paid in 4th year

= ( Cash inflow in 4th year - Depreciation ) * 40%

= ( 500000 + 700000 - 230400 ) 0.4

= 969600 * 0.4

= 387840 is tax paid in 4th year

Whether to buy or not

NPV is negative
Thus equipment should not be bought

CFAD = Cash flow after depreciation = Net cash flow - Depreciation

Tax is calculated on CFAD

CFADT = Cash flow after depreciation = CFAD - Tax

CFBDAT = Cash flow before depreciation and after tax = CFADT + Depreciation

PV = CFBDAT * PVF

NPV is sum of all PVs

Explanation:

Rahul Sunny answered 2 years ago

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