Tatum Corporation recently purchased a $1,200,000 asset that has a three-year service life and no salvage value. The company is subject to a 30% income tax rate and employs a 12% after-tax hurdle rate in capital investment decisions.Management is studying whether to depreciate the asset by using the straight-line method or the Modified Accelerated Cost Recovery System (MACRS). Assume that the following MACRS factors are in effect: year 1, 33%; year 2, 45%; year 3, 15%; and year 4, 7%YearFV of $1 at 12%FV of an ordinary annuity at 12% PV of $1 at 12%PV of an ordinary annuity at 12% 11.1201.0000.8930.89321.2542.1200.7971.69031.4053.3740.7122.40241.5744.7790.6363.03751.7626.3530.5673.60561.9748.1150.5074.111Required:A. Calculate the total depreciation expense that Tatum will record under
each method.B. Calculate the total tax savings that will occur with each method.C. On the basis of your calculations in part "B," which of the two methods will management likely prefer? Explain your answer.D. Compute the present value of the tax savings for each method, rounding to the nearest dollar.
What will be an ideal response?
A. Both methods will result in the total asset cost of $1,200,000 being written off as depreciation expense.
B. Straight-line:
| Year 1: | $200,000 × .3 = | 60,000 × .893 = | $53,580 |
| Year 2: | $400,000 × .3 = | 120,000 × .797 = ? | $95,640 |
| Year 3: | $400,000 × .3 = | 120,000 × .712 = ? | $85,440 |
| Year 4: | $200,000 × .3 = | 60,000 × .636 = | $38,160 |
| TOTAL | ? | ? | $272,820 |
Regardless of the depreciation method chosen (accelerated or the optional straight-line method) the half-year convention must still be followed. (see text, pg. 705)
MACRS:
| Year 1: | $1,200,000 × 0.33 × 0.30 = | $118,800 |
| Year 2: | $1,200,000 × 0.45 × 0.30 = | 162,000 |
| Year 3: | $1,200,000 × 0.15 × 0.30 = | 54,000 |
| Year 4: | $1,200,000 × 0.07 × 0.30 = | 25,200 |
| TOTAL | ? | $360,000 |
| ? | ? | ? |
D.
| Straight-Line | $272,820 | |
| ? | ? | |
| MACRS | ? | ? |
| Year 1: | $118,800 × 0.893 | $106,088 |
| Year 2: | $162,000 × 0.797 | 129,114 |
| Year 3: | $54,000 × 0.712 | 38,448 |
| Year 4: | $25,200 × 0.636 | 16,027 |
| TOTAL | ? | $289,677 |
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