Question

A person has bought an equipment which costs $100,000 to buy and $16,000 to install. The annual operating cost would be $5,000 for the first year and it is expected to increase by $500 thereafter. This equipment will save $40,000 for each year and the life of the equipment is 5 years.

1. Determine depreciation for each year by using MACRS (20%, 32%, 19.2%, 11.52%, 11.52%, and 5.76%)

2. If the person decides to sell this equipment at the end of second year for $80,000. Construct the income statement and cash flow statement by using marginal tax rate at 38%.

Income Statement

Years	0	1	2
Income statement
Revenue
Expenses
Depreciation
Taxable Income
38% taxes
Net Income

Cash Flow Statement

Net Income	0	1	2
Depreciation
Capital Expenditure
Salvage Value
Gains Tax/ Tax Savings
After tax net cash flow

Answer 1

1. Depreciation for each year:

Total equipment cost = Equipment cost + installation cost = $100,000 + $16,000 = $116,000

Depreciation = total equipment cost*depreciation rate

Depreciation for year 1 = $116,000*20% = $23,200

Depreciation for year 2 = $116,000*32% = $37,120

Depreciation for year 3 = $116,000*19.2% = $22,272

Depreciation for year 4 = $116,000*11.52% = $13,363.20

Depreciation for year 5 = $116,000*11.52% = $13,363.20

Depreciation for year 6 = $116,000*5.76% = $6,681.60

2. Income and Cash flow Statement

Income statement

Income statement formula

Cash flow statement

Tax on salvage value is calculated as $80,000*38% = $30,400

Cash flow statement formula