Engineering Economy: Depreciation

In summary, Ellen wants to invest $8500 in expanding her factory, which will increase her revenue by $7000 per year and only increase costs by $1000. The investment consists of $2900 for a building and $5600 for machinery, and US depreciation rules apply. With an income tax rate of 35% and a discount rate of 14%, the net present value for the first nine years of the investment is $21,178.23, taking into account the depreciation deductions.
  • #1
jdawg
367
2

Homework Statement


Ellen wants to expand her factory with a $8500 addition. It will increase revenue by $7,000 per year, and only increase costs by $1,000. The $8500 consists of $2900 for a building and $5600 for machinery. US depreciation rules apply. The income tax rate is 35%. Based on her discount rate of 14%, what is Ellen's net present value for the first nine years of the investment?

Homework Equations

The Attempt at a Solution


When I worked this problem I just ignored the depreciation... Can someone please explain to me how to incorporate depreciation into this problem?
Here is what I did in excel:

Revenue Net Disc Rate Income Tax Taxes Profit PV
$0 (-$8,500) 14% 35% -$8,500.00
$7,000 $6,000 14% 35% $2,100 $3,900 $5,263.16
$7,000 $6,000 14% 35% $2,100 $3,900 $4,616.81
$7,000 $6,000 14% 35% $2,100 $3,900 $4,049.83
$7,000 $6,000 14% 35% $2,100 $3,900 $3,552.48
$7,000 $6,000 14% 35% $2,100 $3,900 $3,116.21
$7,000 $6,000 14% 35% $2,100 $3,900 $2,733.52
$7,000 $6,000 14% 35% $2,100 $3,900 $2,397.82
$7,000 $6,000 14% 35% $2,100 $3,900 $2,103.35
$7,000 $6,000 14% 35% $2,100 $3,900 $1,845.05
NPV: $21,178.23
 
Physics news on Phys.org
  • #2
jdawg said:

Homework Statement


Ellen wants to expand her factory with a $8500 addition. It will increase revenue by $7,000 per year, and only increase costs by $1,000. The $8500 consists of $2900 for a building and $5600 for machinery. US depreciation rules apply. The income tax rate is 35%. Based on her discount rate of 14%, what is Ellen's net present value for the first nine years of the investment?

Homework Equations

The Attempt at a Solution


When I worked this problem I just ignored the depreciation... Can someone please explain to me how to incorporate depreciation into this problem?
Here is what I did in excel:
I added [ code ] tags to preserve the spacing you had.
jdawg said:
Code: 
Revenue            Net                Disc               Rate          Income Tax            Taxes Profit               PV       
$0                    (-$8,500)           14%               35%                                                                        -$8,500.00 
$7,000              $6,000             14%               35%                $2,100                     $3,900               $5,263.16
$7,000               $6,000             14%              35%                 $2,100                 $3,900                 $4,616.81
$7,000               $6,000             14%               35%              $2,100                   $3,900                 $4,049.83
$7,000               $6,000             14%               35%               $2,100                   $3,900               $3,552.48
$7,000              $6,000             14%                35%              $2,100                   $3,900                  $3,116.21
$7,000              $6,000              14%               35%                 $2,100                $3,900                 $2,733.52
$7,000              $6,000              14%               35%                $2,100                $3,900                  $2,397.82
$7,000              $6,000              14%               35%               $2,100                  $3,900                  $2,103.35
$7,000              $6,000              14%               35%                 $2,100                  $3,900               $1,845.05

NPV: $21,178.23
How did you get the present value (PV)? It looks like you are using the net as the future value, and calculating the PV from that. For the depreciation, you can deduct a certain amount per year from the Net, which will reduce the income tax liability. It could be that there are different time intervals that apply for the building and the equipment. I don't know what the rules are, but your book ought to have a similar example.

Let's assume that you can fully deduct the building over a ten-year period, and can deduct the machinery over a 7-year period. This means that you can deduct $270 each year for the building (10% of 2700) and $800 each year for the machinery (1/7 * $5600). That would reduce the net by $1070 per year, which would reduce the income tax by about $360 or so. Again, check your book to see if they talk about different deduction classes or have an example that shows this in use.

One of your columns is labelled "Taxes Profit". That is a confusing label. A better choice would be "After Tax Profits" or similar. I believe that your PV should be calculated from the after-tax profits, rather than from the Net, but I'm not sure about this.
 
  • Like
Likes jdawg
  • #3
Sorry, everything got all jumbled up when I copied it from excel. The order of the columns is supposed to be: Revenue, Net, Discount Rate, Income Tax, Taxes, Profit, PV, NPV.

I still don't quite understand.
 
Last edited:
  • #4
jdawg said:
I still don't quite understand.
What part don't you understand? A specific question would be helpful.
 
  • #5
Nevermind, I read what you wrote again and it clicked! Thanks for your help!
 

Related to Engineering Economy: Depreciation

What is depreciation and why is it important in engineering economy?

Depreciation is the decrease in value of an asset over time due to wear and tear, obsolescence, or other factors. In engineering economy, it is important because it allows us to accurately account for the cost of an asset over its useful life and determine its impact on the company's financial performance.

What are the different methods of depreciation used in engineering economy?

There are several methods of depreciation, including straight-line, declining balance, sum-of-the-years'-digits, and units-of-production. Each method has its own advantages and is suited for different types of assets and industries. It is important to carefully consider which method is most appropriate for a given situation.

How does depreciation affect the profitability of a company?

Depreciation has a direct impact on a company's profitability as it is a non-cash expense that reduces the company's taxable income. This means that the company will pay less in taxes, resulting in higher profits. Depreciation also affects the company's cash flow, as it represents the actual cost of using an asset over its useful life.

Can depreciation be reversed or reversed?

No, depreciation cannot be reversed or erased. Once an asset is depreciated, its value cannot be increased. However, if an asset is sold for more than its book value, a gain on sale is recognized which can offset the depreciation expense.

How does the choice of depreciation method impact the value of an asset?

The choice of depreciation method affects the amount of depreciation expense recognized each year, which in turn affects the book value of the asset. For example, the straight-line method results in equal depreciation expense each year, while the declining balance method results in higher depreciation expense in the earlier years of an asset's life. This can impact the value of an asset on the company's balance sheet and affect financial ratios such as return on assets.

Hot Threads

Recent Insights

Back
Top