Question

Consider an asset with the cost basis of $500,000, useful life of 5 years and salvage value of 10,000 at the end of its useful life. This asset generates yearly revenue of $275,000 and its operating cost is $55,000 per year. Average inflation rate is estimated to be 4% over the next 5 years.

Calculate tax saving in year 2 due to depreciation; if the double declining method is used for depreciation (tax rate is 30%).

(Report your answer in dollar amounts without any extra character. Answers such as 2Million; 2M; 2,000,000 or $2000000 are not acceptable)

Answer 1

Given:

• Cost $500000
• Useful life: 5 yrs
• Salvage value: $10,000
• Yearly revenue: $275000
• Operating cost:$55000/yr
• Inflation rate:4% over next 5 years

Calculate:Tax saving: year 2?(tax rate is 30%)

The double declining balance method is a system designed to accelerate the cost recovery of any asset's depreciable base. It assumes that the assetdepreciates more in the early years rather than in the later stages.

To calculate, DDB, calculate the straight line depreciation (SLD) expense percentage based on the acquisition cost of the asset while ignoring the salvage value and then doubling that percentage to arrive at the DDB.

For the given context, of the machine costing $500,000 and the salvage value of $10,000 and a useful life of 5 years, the SLD or straight line depreciation will be 100%/5=20% per year, DDB will therefore be 20%*2=40% first year.

Therefore the first year depreciation expense for the $500,000 machine would be $500,000*0.40=$200,000

Second year the depreciation expense, $500,000-$200,000=$300,000*40%=$120,000

The tax rate is $120,000*30%=$36000