Question

In: Economics

1. An oil refinery has decided to purchase some new drilling equipment for $550,000. The equipment...

1. An oil refinery has decided to purchase some new drilling equipment for $550,000. The equipment will be kept for 10 years before being sold. The estimated salvage value (SV) for depreciation purposes is to be $25,000. Use this information to solve the following questions:

a) Using the straight-line (SL) method, the annual depreciation on the equipment is _________________.

b) Using the double declining balance (DDB) method, the depreciation charge in year 3 is ______________.

c) Using the SL method, the book value (BV) at the end of the depreciable life is ____________________.

d) If SL depreciation is used and the equipment is sold for $35,000 at the end of the 10 years, the taxable gain (capital gain) on the disposal of the equipment is _________________.

e) If a MACRS depreciation schedule is used (based on a 5-year property class*) and the equipment is sold for $35,000 at the end of the 10 years, the taxable gain (capital gain) on the disposal of the equipment likely to be _________________. (Percentages: 20.00, 32.00, 19.20, 11.52, 11.52, 5.76)

Please answer without using excel or a graphic calculator. Thanks!

Solutions

Expert Solution

Cost=C=$550000

Salvage=S=$25000

Useful life=n=10

a) Using the straight-line (SL) method, the annual depreciation on the equipment is _________________.

Annual Depreciation in case of SL=(C-S)/n=(550000-25000)/10=$52500

b) Using the double declining balance (DDB) method, the depreciation charge in year 3 is ______________.

Under DDB, depreciation rate=200%/n=200%/10=20%

Depreciation in year 1=550000*20%=$110,000

Book Value at the end of year 1=550000-110000=$440,000

Depreciation in year 2=440000*20%=$88,000

Book Value at the end of year 2=440000-88000=$352,000

Depreciation in year 3=352000*20%=$70,400

c) Using the SL method, the book value (BV) at the end of the depreciable life is ____________________.

In SL depreciation, Book value at the end of depreciable life=Salvage value=$25000

d) If SL depreciation is used and the equipment is sold for $35,000 at the end of the 10 years, the taxable gain (capital gain) on the disposal of the equipment is _________________.

Capital gain=Sale Value-BV at the end of depreciable life=35000-25000=$10,000

e) If a MACRS depreciation schedule is used (based on a 5-year property class*) and the equipment is sold for $35,000 at the end of the 10 years, the taxable gain (capital gain) on the disposal of the equipment likely to be

In MACRS depreciation, asset is depreciation to zero.

So, Capital Gain=Sale Value=$35,000


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