Question

You are tasked with comparing the tax savings from two different depreciation methods. You’ve purchased an asset for $100,000. It has a depreciable life of 5 years. The marginal tax rate is $30%. The minimum return on alternative investments is 10%.

If the asset can be depreciated to zero value at the end of 5 years by the “straight line method”, what is the applicable depreciation schedule?

	Schedule A	Schedule B	Schedule C	Schedule D	Schedule E
Year 1	$20k	$20k	$100k	$50k	$75k
Year 2	$20k	$30k	$0	$25k	$25k
Year 3	$20k	$25k	$0	$15k	$0
Year 4	$20k	$15k	$0	$10k	$0
Year 5	$20k	$10k	$0	$0k	$0

Which depreciation schedule would contribute the greatest savings if it were used in an NPV calculation for the asset?

Which depreciation schedule would contribute the least savings in an NPV calculation?

If schedule D were used, how much of the asset is left to be depreciated at the end of Year 2? This is called the “book value” of the asset. That value is tracked by the accounting department as the value of the asset (from a tax perspective) that remains on the “books”.

Answer 1

Cost of asset	100,000
Life	5
Depreciation per year in SLM	1/5	20.00%
So Depreciation of 100000*20%= 20K every year
So applicable schedule is A
Solution 2
Every depreciation schedule will provide annual depreciation which in turn will provide the tax benefit @ 30% so let's calculate
the NPV of the tax benefit generated by depreciation
Year	Schedule A	Tax saving-Schedule A		Schedule B	Tax saving-Schedule B		Schedule C	Tax saving-Schedule C		Schedule D	Tax saving-Schedule D		Schedule E	Tax saving-Schedule E
1	20,000	6,000		20,000	6,000		100,000	30,000		50,000	15,000		75,000	22,500
2	20,000	6,000		30,000	9,000			-		25,000	7,500		25,000	7,500
3	20,000	6,000		25,000	7,500			-		15,000	4,500			-
4	20,000	6,000		15,000	4,500			-		10,000	3,000			-
5	20,000	6,000		10,000	3,000			-			-			-
Now let's calculate the PV of these tax benefits
Year	Tax saving-Schedule A	Tax saving-Schedule B	Tax saving-Schedule C	Tax saving-Schedule D	Tax saving-Schedule E	NPV factor @ 10%	Tax saving-Schedule A	Tax saving-Schedule B	Tax saving-Schedule C	Tax saving-Schedule D	Tax saving-Schedule E
1	6,000	6000	30000	15000	22500	0.909	5,455	5,455	27,273	13,636	20,455	#
2	6,000	9000	0	7500	7500	0.826	4,959	7,438	-	6,198	6,198	#
3	6,000	7500	0	4500	0	0.751	4,508	5,635	-	3,381	-	#
4	6,000	4500	0	3000	0	0.683	4,098	3,074	-	2,049	-	#
5	6,000	3000	0	0	0	0.621	3,726	1,863	-	-	-	#
						NPV of tax saving	22,745	23,464	27,273	25,265	26,653
Greatest saving option	Schedule C
Least saving option	Schedule A
Solution 3
If schedule D is used
Year	Schedule D
1	50,000
2	25,000
Total Depreciation charged	75,000
Cost	100,000
Remaining book value	25,000