Depreciation cost class-life

Suppose you are asked to evaluate the purchase of the multicone cyclone referred to in Example 3.4. The capital investment is 35,000 (see Example 3.4), and the equipment has a class life of 5 years, after which it will be sold for the salvage value of 4000. The income stream generated by the machine is on line A in Tables EB.5A and EB.5B. As the equipment ages, its operating and maintenance costs increase, and line B lists the expense profile. Assume a tax rate of 35 percent with no investment tax credit. Evaluate two possible scenarios (a) 100 percent use of equity and (b) 100 percent debt financing. Use straight-line depreciation for debt financing, for simplicity assume equal annual payments (principal plus interest) to the lender for the 5 years at a rate of 10.5%. 

Tax-law changes put into effect with the 1981 Economic Recovery Act and modified in 1986 have instituted a new system of depreciation known as the Accelerated Cost Recovery System (ACRS). The latter has replaced the former ADR system for most tangible depreciable property used in a trade or business placed in service on or after January 1, 1981. In the ACRS [or Modified Accelerated Cost Recovery System (MACRS) which went into effect for property put into service on or after January 1, 19871, the recovery of capital costs as depreciation was determined over statutory periods of time using statutory percentages depending on the class life of the property and the number of years since the property was placed in service. The statutory periods of time were generally shorter than the useful life of the asset or the period for which it was used to produce income. 

Calculate the percentage factors for a class life of 10 years as presented in Table 3 of this chapter for the Accelerated Cost Recovery System (ACRS). Note that ACRS is based on a HO-percent declining balance with switch to straight-line depreciation at the time appropriate to maximize the deduction. It is also based on salvage value being zero. The half-year convention in the first year applies, but the last half-year deduction cannot be claimed as such. Use an initial property value of 22,000 to permit comparison to Fig. 9-4 and Example 2. 

Description of class life asset Asset depreciation range (ADR) (in years) Asset guideline Lower period Dppcr limit (Midpoint) limit Annual asset guideline repair allowance, percentage of cost... 

Chlorinated polyether, 436, 443 Chlorobenzene, reactor design for production of 718-726 Chloroprene, 435 Chutes, cost of 569 CLADR, 273-275,286-288 Class life depreciation, 270-276, 286-290... 

For the process considered in Example 17.14, but with MACRS depreciation for a 5-yr class life as determined in Example 17.27, calculate, over an estimated life of 15 yr, including years 1997-1999 when the plant is being constructed (a) the NPV for a nominal interest rate of 15% compounded annually and (b) the nominal interest rate for the IRR method (i.e., for NPV = 0). For the first 2 yr of plant operation, when at 45 and 67.5% of capacity, the cost of production, exclusive of depreciation, is 55 million and 78 million, respectively. 

---