Question

Consider the tax depreciation for a $50,000 investment using both the Modified Accelerated Cost Recovery System (MACRS) and the Sum-of-Years’ Digits depreciation accounting systems. Show which system is more beneficial economically. Use a 5-year tax life. The corporate MARR is 25%, and the tax rate is 40%.(show work and formulas)

Answer 1

Macrs rate is categorized in three rates 200%, 150% and 100%. Investment with the tax life of 5 years is fall under the category of 200% depreciation rate. Following is the yearly rate for the 5 year tax life under MACRS.

Year 1	20
Year 2	32
Year 3	19.20
Year 4	11.52
Year 5	11.52
Year 6	5.76

Here for 5 year tax life depreciation is calculated half yearly hence in year 6 half depreciation is calculated for the tax period of 5 years.

Calculation of tax depreciation under MACRS:

Year	Calculation using depreciation	Depreciation amount
1	$50000 * 20%	$10000
2	$50000 * 32%	$16000
3	$50000 * 19.2%	$9600
4	$50000 * 11.52%	$5760
5	$50000 * 11.52%	$5760
6	$50000 * 5.76%	$2880

Total yearly depreciation under this method is provided above.

Calculation of tax depreciation under sum of year digit method

This methods works on the basis of decreasing efficiency of the investment. depreciation is calculated on the basis of fraction part of the sum of all years.

1+2+3+4+5 = 15

Year	Fraction	calculation	Depreciation
1	5/15	50000 * 5/15	$16667
2	4/15	50000 * 4/15	$13333
3	3/15	50000 * 3/15	$10000
4	2/15	50000 * 2/15	$6667
5	1/15	50000 * 1/15	$3333

Suitability of depreciation methods totally depend on the Nature of business. Some business needs to write off investment amount quickly where some of them wants to write off slowly to make equal impact on the profit statement. As compare to MACRS method sum of year digit method is more suitable as tax benefits are comparatively better in this method and there are less fluctuation in the profit of the company.