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Engineering Economy: Depreciation

  1. Apr 30, 2015 #1
    1. The problem statement, all variables and given/known data
    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?

    2. Relevant equations


    3. 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
     
  2. jcsd
  3. Apr 30, 2015 #2

    Mark44

    Staff: Mentor

    I added [ code ] tags to preserve the spacing you had.
    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.
     
  4. Apr 30, 2015 #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: Apr 30, 2015
  5. Apr 30, 2015 #4

    Mark44

    Staff: Mentor

    What part don't you understand? A specific question would be helpful.
     
  6. Apr 30, 2015 #5
    Nevermind, I read what you wrote again and it clicked! Thanks for your help!
     
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