Question

Freedom Corporation acquired a fixed asset for $190,000. Its estimated life at time of purchase was 4 years, with no estimated salvage value. Assume a discount rate of 7% and an income tax rate of 40%. (Use Exhibit 12.4, Appendix C, TABLE 1 and Appendix C, TABLE 2.)

Required:
What is the incremental present value of the tax benefits resulting from calculating depreciation using the sum-of-the-years’-digits (SYD) method rather than the straight-line (SLN) method on this asset? Use the SYD and SLN functions in Excel to calculate depreciation charges.

Answer 1

To find the incremental present value of tax benefits from using SYD over SLN depreciation, calculate yearly tax savings due to higher SYD depreciation and then discount those savings to present value at a 7% rate.

Step-by-step explanation:

The question concerns the calculation of the incremental present discounted value of tax benefits derived from using two different methods of depreciation: sum-of-the-years’-digits (SYD) and straight-line (SLN) for a fixed asset acquired by Freedom Corporation. Under the SYD method, more depreciation is taken in the early years compared to the SLN method, which spreads the depreciation evenly over the asset's useful life. To calculate the incremental present value of the tax benefits, we would need to subtract the SLN depreciation from the SYD depreciation for each year, calculate the tax savings from the higher SYD depreciation, and then discount those savings back to present value using the given discount rate of 7%. Since there is no salvage value, the total depreciable amount is the acquisition cost of the asset, which is $190,000. Applying the income tax rate of 40%, we would calculate the tax savings each year and the present value using the formula provided in Table C1.