Ash purchased $500,000 worth of 5-year equipment for use in his business. What is the present...

Ash purchased $500,000 worth of 5-year equipment for use in his business. What is the present value of the savings under bonus depreciation (compared to MACRS depreciation)? Ash’s marginal tax rate in all years is 40 percent and his cost of capital is estimated to be 10 percent.

How would Ash analyze whether this is a wise investment?

This is all I have no more information available.

Expert Solution

Under Macrs Depreciation: Depreciation allows a business to write off the cost of an asset over its useful life, or the number of years the asset will be used in the business. In our case, a $500,000 piece of equipment that you’ll use for 5 years, rather than expense the full $500,000 in year one, you might write off $100,000 per year for 5 years. Present value after 1st year = $500,000 -$100,000 = $400,000

Under Bonus Depreciation: The depreciable basis of the purchased asset is $500,000 with bonus depreciation of 50% allowed. This means that $250,000 ($500,000 times 50%) is allowed for bonus depreciation plus the amount of depreciation based on the traditional MACRS calculation - but with the depreciable basis adjusted downward by the $250,000 bonus amount. Thus, the remaining $250,000 will be depreciated utilizing the regular 5- year property class MACRS percentages. For example, in year one there would be an additional $25,000 ($250,000 times 10%) of MACRS depreciation. This represents a total first-year deduction of $275,000 of depreciation instead of $100,000 based on the traditional $500,000 over the 5-year MACRS class without bonus depreciation. This means that the project will generate an additional $175,000 in first year tax depreciation, but the project will generate less depreciation in the remaining years. The reductions, relative to regular MACRS without bonus depreciation.

Present Value after 1st year = $500,000 - $275,000 = $225,000

Impact of Bonus Depreciation on Effective Tax Rates

Bonus depreciation reduces the effective tax rate on investment because it increases the net present value of the depreciation allowance. Compared to regular tax depreciation, bonus depreciation increases the net present value of deductions by 18 percent (30 percent bonus).

Bonus Depreciation is a wise investment.

ekkarill92 answered 1 year ago

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