Engineering Economy: Depreciation

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Discussion Overview

The discussion revolves around a homework problem related to engineering economy, specifically focusing on how to incorporate depreciation into the calculation of net present value (NPV) for an investment in a factory expansion. Participants explore the impact of depreciation on tax liabilities and overall profitability over a nine-year period.

Discussion Character

  • Homework-related, Technical explanation, Conceptual clarification

Main Points Raised

  • One participant initially ignored depreciation in their NPV calculation and seeks clarification on how to include it.
  • Another participant suggests that depreciation can reduce taxable income, thereby affecting the net profit and tax liability.
  • There is a proposal to deduct different amounts for the building and machinery based on assumed depreciation schedules (10 years for the building and 7 years for the machinery).
  • Confusion arises regarding the labeling of columns in the Excel spreadsheet, particularly the term "Taxes Profit," which is suggested to be renamed for clarity.
  • One participant expresses a lack of understanding and requests specific questions to clarify their confusion.
  • A later reply indicates that the participant found the previous explanations helpful after reviewing them again.

Areas of Agreement / Disagreement

Participants do not reach a consensus on the exact method for incorporating depreciation into the NPV calculation, and some uncertainty remains regarding the correct labeling of financial terms and the specific depreciation rules applicable to the scenario.

Contextual Notes

There are unresolved assumptions regarding the depreciation rates and tax implications, as well as the specific calculations used to derive present value from net profits.

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