
1.
Prepare a five-column table with the below that reports amount using the straight-line
- a. Pretax income before depreciation,
- b. Straight-line depreciation expense,
- c. Taxable income,
- d. Income taxes, and
- e. Net
cash flow .
1.

Explanation of Solution
Cash flow:
Cash flow is the monetary consideration (return or income) received by the business for its long-term capital investment.
Straight-line depreciation method:
The depreciation method which assumes that the consumption of economic benefits of long-term asset could be distributed equally throughout the useful life of the asset, is referred to as straight-line method.
Prepare a five-column table that reports amounts using the straight-line depreciation for each of the six years as follows:
Years | (a) | (b) | (c) | (d) | (e) |
Income Before Depreciation | Straight-Line Depreciation | Taxable Income | Income Taxes @ 40% | Net Cash Flows | |
| |||||
Year 1 | $12,000 | $3,000 | $9,000 | $3,600 | $8,400 |
Year 2 | 12,000 | 6,000 | 6,000 | 2,400 | 9,600 |
Year 3 | 12,000 | 6,000 | 6,000 | 2,400 | 9,600 |
Year 4 | 12,000 | 6,000 | 6,000 | 2,400 | 9,600 |
Year 5 | 12,000 | 6,000 | 6,000 | 2,400 | 9,600 |
Year 6 | $12,000 | $3,000 | $9,000 | $3,600 | $8,400 |
Table (1)
2.
Prepare a five-column table with the below that reports amount using the MACRS depreciation method for each of the six years:
- a. Pretax income before depreciation,
- b. MACRS depreciation expense,
- c. Taxable income,
- d. Income taxes, and
- e. Net cash flow.
2.

Explanation of Solution
Cash flow:
Cash flow is the monetary consideration (return or income) received by the business for its long-term capital investment.
Modified accelerated cost recovery system (MACRS):
This is a depreciation method permitted by Internal Revenue Service to be used for tax purposes because this method allows to record higher depreciation expense for certain years.
Prepare a five-column table that reports amounts using MACRS depreciation method for each of the six years as follows:
Years | (a) | (b) | (c) | (d) | (e) |
Income Before Depreciation | MACRS Depreciation | Taxable Income | Income Taxes @ 40% | Net Cash Flows | |
| |||||
Year 1 | 12,000 | $6,000 | $ 6,000 | $2,400 | $ 9,600 |
Year 2 | 12,000 | 9,600 | 2,400 | 960 | 11,040 |
Year 3 | 12,000 | 5,760 | 6,240 | 2,496 | 9,504 |
Year 4 | 12,000 | 3,456 | 8,544 | 3,418 | 8,582 |
Year 5 | 12,000 | 3,456 | 8,544 | 3,418 | 8,582 |
Year 6 | 12,000 | 1,728 | 10,272 | 4,109 | 7,891 |
Table (2)
3.
Compute the
3.

Explanation of Solution
Net present value method:
Net present value method is the method which is used to compare the initial
Compute the net present value of the investment under straight-line depreciation method, using 10% discount rate as follows:
Particulars | Cash flows Amount ($) (a) | PV Factor @ 10 % (b) | Present value |
Net cash inflows: | |||
Year 1 | $ 8,400 | 0.9091 | $ 7,636 |
Year 2 | 9,600 | 0.8264 | 7,933 |
Year 3 | 9,600 | 0.7513 | 7,212 |
Year 4 | 9,600 | 0.683 | 6,557 |
Year 5 | 9,600 | 0.6209 | 5,961 |
Year 6 | 8,400 | 0.5645 | 4,742 |
Total | $55,200 | $40,041 | |
Less: Amount invested | 30,000 | ||
Net present value | $10,041 |
Table (3)
Note:
- For the present value factors refer Table B.1 in appendix-B.
4.
Compute the net present value of the investment under MACRS depreciation method, using 10% discount rate.
4.

Explanation of Solution
Net present value method:
Net present value method is the method which is used to compare the initial cash outflow of investment with the present value of its cash inflows. In the net present value, the interest rate is desired by the business based on the net income from the investment, and it is also called as the discounted cash flow method.
Compute the net present value of the investment under MACRS depreciation method, using 10% discount rate as follows:
Particulars | Cash flows Amount ($) (a) | PV Factor @ 10 % (b) | Present value |
Net cash inflows: | |||
Year 1 | $ 9,600 | 0.9091 | $ 8,727 |
Year 2 | 11,040 | 0.8264 | 9,123 |
Year 3 | 9,504 | 0.7513 | 7,140 |
Year 4 | 8,582 | 0.6830 | 5,862 |
Year 5 | 8,582 | 0.6209 | 5,329 |
Year 6 | 7,891 | 0.5645 | 4,454 |
Total | $55,199 | 40,635 | |
Less: Amount invested | 30,000 | ||
Net present value | $10,635 |
Table (4)
Note:
- For the present value factors refer Table B.1 in appendix-B.
5.
Explain the reason for the increase in net present value under MACRS depreciation method.
5.

Explanation of Solution
Explain the reason for the increase in net present value under MACRS depreciation method as follows:
From the above explanation it is clear that the net present value under MACRS depreciation method is higher than the net present value under straight-line depreciation method. This is due to the larger cash flows of the asset’s life in the earlier years. Hence, the depreciation deductions are also larger under MACRS depreciation method and thus this result in a less income tax payments in the earlier years.
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Chapter 25 Solutions
Principles of Financial Accounting, Chapters 1-17 - With Access (Looseleaf)
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