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Plastic Recycling Company - MACRS & Straight Line Depreciation

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Plastic Recycling Company is just starting operations with new equipment costing $30,000 and a useful life of five years. At the end of five years the equipment probably can be sold for $5,000. The company is concerned with its cash flow and wants a comparison of straight-line and MACRS1 depreciation to help management decide which depreciation method to use for financial statements and for its income tax return. Assume a 40 percent tax rate.
Chapter Twenty-Seven Longer-Run Decisions: Capital Budgeting 901
1Modified Accelerated Cost Recovery System (effective for assets placed in use after December 31, 1986.)

Calculate the difference in taxable income and cash inflow under each method. Assume MACRS allowances are 20, 32, 18, 15, and 15 percent for years 1-5 respectively.

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Solution Summary

The solution shows step by step calculations of computing depreciation under both MACRS and straight line methods. Also, it shows the effect of using these depreciation methods on taxable income and cash flows.

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a. Calculate the difference in taxable income and cash inflow under each method. Assume MACRS allowances are 20, 32, 18, 15, and 15 percent for years 1-5 respectively.
Solution:
Year 1 Year 2 Year 3 Year 4 Year 5
Difference in taxable income $1,000 $4,600 $400 ($500) ($500)
Difference in cash flows ($400) ($1,840) ($160) $200 $2,200

Workings:
Straight-line depreciation per year = ($30,000 - $5,000 salvage)/5 years = $5,000 per year
MACRS MACRS
rates depreciation
20% $ 6,000 ...

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Radhika Lakshmi, MPhil
Education
  • MPhil, Madurai Kamaraj University
  • MCom, Annamalai University
  • IATA, International Air Transport Association
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