Depreciation methods

For this example, the tax-basis depreciation method in line-item 11 is a straight-line calculation based on the capitalized fixed capital, ie, fixed capital plus interest to the start of operation any salvage should be subtracted from the capitalized fixed capital and the result divided by the number of expected operating years to obtain the aimual tax-basis depreciation. 

FIG. 9-5 Book value against time for various depreciation methods. 

Figures 9-6, 9-7, and 9-8 show the effect of the depreciation method on profit for a project described by the following data ...

Example 2 Net Present Value for Different Depreciation Methods The following data descrihe a project. Revenue from annual sales and the total annual expense over a 10-year period are given in the first three columns of Table 9-5. The fixed-capital investment Cpc is 1,000,000. Plant items have a zero salvage value. Working capital C vc is 90,000, and cost of land C/ is 10,000. There are no tax allowances other than depreciation i.e., is zero. The fractional tax rate t is 0.50. 

We shall calculate for these data the net present value (NPV) for the following depreciation methods and discount factors ... 

Three different depreciation methods are recognized by the Internal Revenue Service. They are ... 

The straight-line depreciation method reduces the asset value by the same amount for each year of the plant s expected life. The amount can be determined by dividing the total amount that can be depreciated by the number of years the plant is expected to last. This is the easiest of the depreciation methods. 

If, however, in the fourth year the straight-line depreciation method had been adopted, the full plant could be depreciated by the end of 6 years. At the beginning of the fourth year the book value was 1,778,000 and there were 3 years of expected life remaining. By the straight-line method this would mean the plant should be depreciated 593,000 in each of the last 3 years. 

The answers obtained in Example 1 1-6 are typical of those usually obtained. If earnings are the only consideration, the straight-line depreciation method is the worst plan to use. However, the present values for the other methods are generally so close that no obviously best one can be picked. 

Amortization is basically the same as depreciation except that it applies to intangible property, such as franchises, designs, drawings, or research expenses. Generally straight-line depreciation methods must be used, and only certain items that are amortized can be deducted as expenditures for federal income tax purposes. The value of goodwill, trademarks, and trade names generally cannot be amortized. 

Chapter 3 treats the most common type of objective function, the cost or revenue function. Historically, the majority of optimization applications have involved trade-offs between capital costs and operating costs. The nature of the trade-off depends on a number of assumptions such as the desired rate of return on investment, service life, depreciation method, and so on. While an objective function based on net present value is preferred for the purposes of optimization, discounted cash flow based on spreadsheet analysis can be employed as well. 

When the double declining method is considered, = 2/N, the annual depreciation is twice that of straight-line depreciation and the amount depreciated decreases with increase in the value of n. In the case of double declining balance depreciation method, the book value P—HDn in the nth year is given by4 ... 

Income-tax laws permit recovery of funds by two accelerated depreciation schedules as well as by straight-line methods. Since cash-flow timing is affected, choice of depreciation method affects profitability significantly. Depending on the ratio of depreciable to nondepreciable assets involved, two projects which look equivalent before taxes, or rank in one order, may rank entirely differently when considered after taxes. Though cash costs and sales values may be equal on two projects, their reported net incomes for tax purposes may be different, and one will show a greater net profit than the other. 

Prior to 1954, the United States government would not accept any depreciation method which permitted depreciation rates more than 50 percent greater than those involved in the straight-line method. In 1954, the laws were changed to allow rates up to twice (200 percent) those for the straight-line method. Under these conditions, one arbitrary method for choosing the value of... 

Comparison of the various depreciation methods shows that the declining-balance and the sum-of-the-years-digits methods give similar results. In both cases, the depreciation costs are greater in the early-life years of the property than in the later years. Annual depreciation costs are constant when the straight-line, sinking-fund, or present-worth method is used. Because interest effects are included in the sinking-fund and present-worth methods, the annual decrease in asset value with these two methods is lower in the early-life years than in the... 

The final choice of the best depreciation method depends on a number of different factors. The type and function of the property involved is, of course, one important factor. Also, it is desirable to use a simple formula giving results as accurate as the estimated values involved. The advisability of keeping two separate sets of books, one for income-tax purposes and one for company purposes, should be considered. The final decision involves application of good judgment and an analysis of the existing circumstances. 

Notes should be included with the table to explain the basis for special factors used, such as escalation factors, startup costs, and depreciation method. The notes can also be used to explain the methods used for estimating the various items as, for example, note 4 in Table 2 showing the methods used for estimating lines 5, 6, and 7. 

A multiple-effect evaporator is to be used for evaporating 400,000 lb of water per day from a salt solution. The total initial cost for the first effect is 18,000, and each additional effect costs 15,000. The life period is estimated to be 10 years, and the salvage or scrap value at the end of the life period may be assumed to be zero. The straight-line depreciation method is used. Fixed charges minus depreciation are 15 percent yearly based on the first cost of the equipment. Steam costs 1.50 per 1000 lb. Annual maintenance charges are 5 percent of the initial equipment cost. All other costs are independent of the number of effects. The unit will operate 300 days per year. If the pounds of water evaporated per pound of steam equals 0.85 x number of effects, determine the optimum number of effects for minimum annual cost. 

Conduct an economic analysis and decide between the one- and two-reactor systems. The two costs to be considered are depreciation of capital and power cost for agitation. Using the volumes, 20-year life with no salvage, and the straight-line depreciation method ... 

There are several depreciation methods, which are discussed in many economic tercts. Since we want to develop a rapid method of estimating the production cost, we will use the simple linear depreciation method. For this method, divide the difference of the depreciable capital cost and its salvage value by the Ufe of the plant, as shown in Table 2.1. An entire plant or individual equipment has three lives an economic life, a physical life, and a tax life. The economic hfe occurs when a plant becomes obsolete, a physical hfe when a plant becomes too costly to maintain, and a tax life, which is fixed by the government. The plant life is usually ten to twenty years. The depreciable capital cost includes all the costs incurred in building a plant up to the point where the plant is ready to produce, except land and site-development costs. Care must be taken not to include costs that are not depreciable. 

---