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September 15, 2019 at 11:56 pm #2707665
I want to know why the salvage value is not subtracted from the original cost in calculating depreciation. The answer or question does NOT say that they used Double Declining Balance method which ignores salvage value when calculating depreciation expense. Is it because the question says that “equipment will be fully depreciated 30 40 and 30 percent in each of the three years”?
McLean Inc. is considering the purchase of a new machine that will cost $150,000. The
machine has an estimated useful life of three years. Assume for simplicity that the
equipment will be fully depreciated 30, 40, and 30 percent in each of the three years,
respectively. The new machine will have a $10,000 resale value at the end of its
estimated useful life. The machine is expected to save the company $85,000 per year in
operating expenses. McLean uses a 40 percent estimated income tax rate and a 16
percent hurdle rate to evaluate capital projects.September 16, 2019 at 9:35 am #2707983Painted_JeansParticipant
omg thats a nightmare…. sorry i hate BECSeptember 16, 2019 at 11:10 am #2708157sayParticipant
That is one of those tricky A$$ questions. It is a declining method, not double declining, but based on the information given it is a declining method in which you do not take out the salvage value. The only thing you do with the salvage is multiply it by the discount factor and add it to the discounted cash savings. You take the depreciation per year and multiply it by the tax rate to calculate the tax shield to include in the NPV calc.September 16, 2019 at 1:08 pm #2708304Biff TannenParticipant
If I remember correctly, salvage value is an inflow of monies, since it’s assumed that the PPE will be sold at some point, which will create an inflow of cash. This inflow needs to be factored in to your cash flows analysis.September 16, 2019 at 5:54 pm #2708733
Thanks all! So, whether the company uses a Double Decling balance method or Declining balance method salvage value is ignored, which means the depreciation base amount is just the initial cost of equipment. I use becker and this question was included in the texbook questions. When I saw this question again when doing MCQs I got wrong answer because I took the salvage value out from the depreciation base amount. Personally, I think BEC is more difficult than FAR 🙁September 16, 2019 at 7:32 pm #2708841sayParticipant
That is interesting. I can't remember if I had this kind of question in my test bank. The questions I had either had depreciation to consider, or the salvage value, but never both presented at the same time. Good to know. Now I am confused, because I would think if you did have straight line and salvage, you would consider the correct depreciation expense amount because it is the tax shield/savings. I would think you would include it under those factors. I pray I passed BEC b/c I don't want to have to revisit this again lol!September 16, 2019 at 9:10 pm #2709000
Yes, if S/L method is used, factor the salvage value into depreciation base amount. What I mean by “salvage value is ignored” in my previous post was only when you calculate the depreciation expense. Whatever depreciation method you use, when calculating NPV, the salvage value (after-tax), if not $0, must be included in the terminal year as cash inflow.