Straight-line method for determining depreciation

In the straight-line method for determining depreciation, it is assumed that the value of the property decreases linearly with time. Equal amounts are charged for depreciation each year throughout the entire service life of the property. The annual depreciation cost may be expressed in equation form as follows ... 

Fixed capital investments are characterized by the fact that they have to be replaced after a number of years commonly referred to as service life or useful life period. This replacement is not necessarily due to wear and tear of equipment. Other factors include technological advances that may render the equipment obsolete. Furthermore, over the usefiil life of the equipment, the plant should plan to recover the capital cost expenditure. In this regard, the notion of depreciation is useful. Depreciation or amortization is an annual allowance which is set aside to account for the wear, tear, and obsolescence of a process such that by the end of the useful life of the process, enough fund is accumulated to replace the process. The simplest method for determining depreciation is referred to as the straight line method in which... 

Depreciation. Depreciation arises from two causes deterioration and outdatedness (economically). These two causes do not necessarily operate at the same rate, and the one having the faster rate determines the economic life of the project. Depreciation is an expense, and there are several permissible ways of allocating it. For engineering purposes, depreciation is usually calculated by the straight-line method for the economic life of the project. Frequently, economic lives of 10 years or less are assumed for projects of less than 250,000. 

Comparison of straight-line, multiple straight-line, sum-of-the-years-digits, and declining-balance methods for determining depreciation. 

The current methods for determining aimual depreciation charges are the straight-line depreciation and the Modified Accelerated Cost Recovery System (MACRS). In the straight-line method, the cost of an asset is distributed over its expected useful life such that the annual charge is... 

In Equation 8.3-1, D is depreciation, FCI is fixed-capital investment, t is the number of years over which the depreciation is accounted for, and S is the salvage value. Thus S is the value the plant could be sold for after the t years of operation. In this discussion we assume that the plant lasts for ten years, and that its salvage value is zero. With the straight-line method, annual depreciation costs are constant. Other methods, such as the sum-of-the-years-digits method, determine depreciation costs to be greater in the early years of the property than in the later years. Local regulatory laws generally define which method can be used to determine depreciation costs. 

Because of its simplicity, the straight-line method is widely used for determining depreciation costs. In general, design engineers report economic evaluations on the basis of straight-line depreciation unless there is some specific reason for using one of the other methods. 

In order to make it worthwhile to purchase a new piece of equipment, the annual depreciation costs for the equipment cannot exceed 3000 at any time. The original cost of the equipment is 30,000, and it has zero salvage and scrap value. Determine the length of service life necessary if the equipment is depreciated (a) by the sum-of-the-years-digits method, and (b) by the straight-line method. 

A proposal has been made to replace the present piece of property by one of more advanced design. The proposed equipment would cost 40,000, and the operating costs would be 15,000/year. The service life is estimated to be 10 years with a nonzero salvage value. Each piece of equipment will perform the same service, and all costs other than those for operation and depreciation will remain constant. Depreciation costs are determined by the straight-line method. The company will not make any unnecessary investments in equipment unless it can obtain an annual return on the necessary capital of at least 10 percent. 

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. 

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. 

A discussion of three representative depreciation methods that have been widely used to determine the depreciation allowed each year is provided. Currently, only the straight line and double declining balance methods are approved by the IRS. The sum of the years digits method has been used previously and is included here for conpleteness. 

The amount a company depreciates an asset is called depreciable cost. This is determined by the cost of the asset less its salvage value. Salvage value is an estimate of the value of the asset after its useful life. In the previous example, if the cost of the equipment is 12,000 and the estimated salvage value is 2,000 for the equipment after its useful life of 5 years, then this equipment can be depreciated by 10,000 or 2,000 per year (Table 3.3). To clearly illustrate straight-line depreciation for this example, consider the following Straight-line depreciation method example ... 

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