Question

Submit your solution to the problem in an Excel file. Explain your answer as necessary and be sure your calculations are clearly shown.

ABC Corporation is large and profitable. This year it is considering buying factory equipment for $100,000,000. ABC’s cost of capital is 7%.

Required:

a) What is the after-tax cost of the equipment if it qualifies for 100% bonus depreciation?

b) What is the after-tax cost of the equipment if it is depreciated using MACRS (7 year recovery period)?

c)How might the tax treatment of the purchase affect ABC’s decision?

d) Comment on the economic policy purpose of Congress in enacting bonus depreciation.

Answer 1

Answer :

Assumption :

Tax rate assumed as 30%

Depreciation under 7 year recovery on half year convention and GDS

(a).

100% bonus depreciation means tax deduction of full value

Tax savings = 100,000,000 * 30% = 30,000,000

PV of benefit = 30,000,000*(1+7%)^{^} -1 = 28037383

Net investment cost after tax = 100,000,000 - 28037383 = 71,962,617

(b).

working (dep rate from MACRS table)

Year	Dep Y1	Dep allowed	Tax Benefit	PV of tax benefit
1	14.29%	14290000	4287000	4006542
2	24.49%	24490000	7347000	6417154
3	17.49%	17490000	5247000	4283115
4	12.49%	12490000	3747000	2858568
5	8.93%	8930000	2679000	1910090
6	8.92%	8920000	2676000	1783132
7	8.93%	8930000	2679000	1668347
8	4.46%	4460000	1338000	778728
-	-	-	-	23705676

Net investment cost after tax = 100,000,000 - 23705676 = 76,294,324

(c).

As is evident under 100% bonus depreciation the present value of investment is lower as compared to standard 7 years and hence if it is available it is preferred

(d).

The purpose of this bonus depreciation was to help business recover investment spendings quick and in process this incentive facilitating simulate economy.