Contemporary Engineering Economics, Fifth Edition, by Chan S. Park.

ISBN: 0-13-611848-8
2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Chapter 9 Depreciation and Corporate Taxes

Economic Depreciation
Note: For most up-to-date depreciation and income tax information, consult the books
website at http://www.prenhall.com and click on Tax Information
9.1

The loss of value is defined as the purchase price of an asset less its market
value, also known as economic depreciation. Economic depreciation = $20,000
- $7,000 = $13, 000

9.2

Economic depreciation = $20,000 - $14,000 = $6,000

Cost Basis
9.3

Total property value with the house:

Original cost
Add: New building
Demolition expenses
Property value

Land
$155,000

$155,000

Building
$245,000
$1,250,000
$15,000
$1,510,000

Total property value = $155,000+ $1,510,000= $1,665,000

Unrecognized loss (demolition of house) = $245,000

9.4

Cost basis for depreciation = $15,000+ $1,250,000 + $245,000 = $1,510,000

(Note: The demolition expense is treated as a site preparation expense)
Cost basis for flexible manufacturing cells:
Flexible Manufacturing cells ($400,000 x 3)
Freight charges
Handling fee
Site preparation costs
Start-up and testing costs
Special wiring and material costs
Cost basis

$1,200,000
$20,000
$15,000
$45,000
$24,000
$3,500
$1,307,500

(Note: start-up and testing costs = $20 x 40 x 6 x 5 = $24,000)

Page | 1

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
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9.5

Unrecognized profit
Old drill press (Book value)
Trade-in allowance
Unrecognized loss

$46,220
$40,000
$6,220

Cost basis
Cost of new drill
Plus: unrecognized loss
Cost basis of new drill

$148,000
$6,220
$154,200

Comments: If the old drill were sold on the market (instead of trade-in), there
would be no unrecognized loss. In that situation, the cost basis for the new drill
would be $148,000.

9.6

Unrecognized profit
Old lift truck (Book value)
Trade-in allowance
Unrecognized gains

$7,808
$9,000
$1,192

Cost basis
Cost of new truck
Minus: unrecognized gains
Cost basis of new truck

$38,000
$1,192
$36,808

Comments: If the old truck were sold on the market (instead of trade-in), there
would be no unrecognized gains. In that situation, the cost basis for the new
drill would be $38,000.

Book Depreciation Methods

9.7
n

(a) SL
Dn

(b) DDB
Bn

Dn

Bn

$27,000

$138,000

$66,000

$99,000

$27,000

$111,000

$39,600

$59,400

$27,000

$84,000

$23,760

$35,640

$27,000

$57,000

$5,640

$30,000

$27,000

$30,000

$30,000
Page | 2

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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9.8

Given: I = $125,000, n = 3 years, N = 8.

1
8
D3 = 0.25 125, 000 (1 0.25)31

= 2( ) = 0.25
= $17,578

9.9

DDB switching to SL:

n

Dn

Bn

1
2
3
4
5
6
7

$20,857
$14,898
$10,641
$7,601
$5,429
$5,287
$5,287

$52,143
$37,245
$26,603
$19,002
$13,573
$8,287
$3,000

9.10 Given: I = $88,000, S = $13,000, N = 6 years.

(a) D1 = $29,333 , D2 = $19,556 , D3 = $13, 037 , D4 = $8,691
(b) DDB Switching to SL
Dn
n

Bn

1
2
3
4

$29,333
$19,556
$13,037
$8,691

$58,667
$39,111
$26,074
$17,383

$4,383

$13,000

$0

$13,000

Comments: If the regular DDB deduction were taken during the fifth year,
B5 would be less than the salvage value. Therefore, it is necessary to adjust D5 .
The number in the box represents the adjusted value. No switching is common for
this type of situation whenever the salvage value is high.

Page | 3

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

9.11 Given: I = $246,000, S = $36,000, N = 8 years

n

Dn

1
2
3
4
5
6
7
8

$61,500
$46,125
$34,594
$25,945
$19,459
$14,594
$7,783
0

Bn
$184,500
$138,375
$103,781
$77,836
$58,377
$43,783
$36,000
$36,000

9.12

1
(a) = 2 = 0.4
5
(b) D2 = (0.4)(0.6)(36, 000) = $8, 640
(c) B4 = (36, 000)(1 0.4) 4 = $4, 665.60

9.13 Given: I = $55,000, N = 5 years, S = $5,000

n

(a) SL

1
2
3
4
5

(b) DDB

$10,000
$10,000
$10,000
$10,000
$10,000

$22,000
$13,200
$7,920
$4,752
$2,128

9.14 Given: I = $56,000, S = $6,500, N = 12 years

$56, 000 $6,500

= $4,125
12

(a)

D=

(b)

D3 = $6, 481

Page | 4

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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Units-of-Production Method
9.15 Allowed depreciation amount
D=

$90, 000 $5, 000

(30, 000) = $10, 200
250, 000

9.16

$68, 000 $7,500

(5,500)
50, 000
= $6, 655

D5,000 hours =

9.17
(a) Straight line: D1 =
(b) UP: D1 =

157, 000 27, 000

= 13, 000; B1 = $144, 000
10

157, 000 27, 000

(23, 450) = 12,194; B1 = $144,806
250, 000

(c) Working hours:

D1 =

157, 000 27, 000

(2, 450) = 10, 616.67; B1 = $146,383.33
30, 000

(d) DDB(without conversion to SL): D1 = 0.2(157, 000) = 31, 400; B1 = $125, 600
(e) DDB(with conversion to SL): D1 = 0.2(157, 000) = 31, 400; B1 = $125, 600
Note that: (d) and (e) are indifferent in year 1.

Tax Depreciation
9.18 Given: I = $265,000, Delivery and installment costs =$46,000, N = 12 years,
and 7-year MACRS
(a) Cost basis = $265,000 + $46,000 = $311,000

Page | 5

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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(b)
n

MACRS Depreciation

1
2
3
4
5
6
7
8

$44,442
$76,164
$54,394
$38,844
$27,772
$27,741
$27,772
$13,855

9.19 Given: I = $35,000, S = $6,000, N = 8 years, and 5-year MACRS

n

Book Depreciation

MACRS Depreciation

1
2
3
4
5
6
7
8

$3,625
$3,625
$3,625
$3,625
$3,625
$3,625
$3,625
$3,625

$7,000
$11,200
$6,720
$4,032
$4,032
$2,016
-

9.20 (a) Cost basis: $190, 000 + $25, 000 = $215, 000
(b)

D1 = $30, 723.5, D2 = $52, 653.5, D3 = $37, 603.5, D4 = $26,853.5

D5 = D7 = $19,199.5, D6 = $19,178, D8 = $9,589

9.21 Given: I = $100,000, S = $20,000, N = 7 years

(a) MACRS-7 year
class: B3 = $100,000 (0.1429 + 0.2449 + 0.1749)($100,000) = $43,730
$100, 000 $20, 000
(b) SL: B3 = $100, 000 3
= $65, 714.29
7

The Difference is $21,984.29.

Page | 6

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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9.22 Let I denote the cost basis for the equipment.

B3 = I ( D1 + D2 + D3 ) I
= I (0.1429 + 0.2449 + 0.1749) I
= I 0.5627 I
= 0.4373($185, 000)
= $80,901

9.23 Given: I = $92,000, S = $12,000, N = 5 years, 7-year MACRS depreciation

class

D1 = $13,147
D2 = $22,531
D3 = $16, 091
D4 = $11, 491
D5 = $8, 216

9.24 Given: I = $50,000, tax depreciation method = 6-year MACRS property

class with half-year convention
200% DB

SL

MACRS

Dn

Dn

Bn 1

Dn

1
2

$50, 000
$41, 667

$8,333
$13,889

6.5 $7692
5.5 $7,576

$8,333
$13,889

$27, 778

$9, 259

4.5

$6,173

$9, 259

$18,519

$6,173

3.5 $5, 291

$6,173

$12,346

$4,115

2.5 $4,938

$4,938

1.5 $4,938
0.5 $2, 469

$4,938
$2, 469

6
7

life

: Optimal time to switch

9.25 Since the land is not depreciable, just consider the building depreciations.
Given: I = $250,000, tax depreciation method = 27.5-year MACRS property

Page | 7

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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Depreciation
Allowed
rate
depreciation
n
1
2.5758%
$6,439
2
3.6364%
$9,091
3
3.6364%
$9,091
4
3.6364%
$9,091
5

3.1818%

$7,955

9.26 Given: I = $33,000 and 7-year MACRS property

n
Dn
1 $4, 716
2 $8, 082
3 $5, 772
4 $4,122
5 $2,947
6 $2,944

7 $2,947
8 $1, 472
9.27 Given: Residential real property (27.5-year), I = $270,000
(a)
100% 2.5
D1 =

27.5 12
= (0.00758)($270, 000) = $2, 045
(b) Total amount of depreciation over the 4-year ownership, assuming that the
asset is sold at the end of 4th calendar year:
n

Rate

Dn

1 0.7576% $2,045
2 3.6364% $9,818
3 3.6364% $9,818
4 3.4848% $9, 049

Total amount of depreciation allowed = $31,091. Note that the 4th year
depreciation reflects the mid-month convention (11.5 months).
B4 = $270, 000 $31, 091 = $238,909

Page | 8

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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9.28
Types of Asset
Depreciating Methods
End of year
Initial Cost ($)
Salvage value ($)
Book value ($)
Depreciation life
Depreciable Amount ($)
Accumulated Depreciable ($)

I
SL
6
30,000
6,000
12,000
8 yr
3,000
18,000

II
DDB
3
25,000
5,000
5,400
5 yr
3,600
19,600

III
UP
3
41,000
5,000
20,500
90,000 mi
6,000
18,000

IV
MACRS
4
20,000
2,000
3,456
5 yr
2,304
16,544

9.29
(a) Book depreciation methods:
Straight-line method:
n

1
2
3
4
5

Dn

Bn

Cum. Dn

$15,800

$73,200

$15,800

$15,800
$15,800

$57,400
$41,600

$31,600
$47,400

$15,800

$25,800

$63,200

$15,800

$10,000

$79,000

DDB method:
n

1
2
3
4
5

Dn

Cum. Dn

Bn

$35,600

$53,400

$35,600

$21,360
$12,816
$7,690
$1,534

$32,040
$19,224
$11,534
$10,000

$56,960
$69,776
$77,466
$79,000

(b) Tax depreciation: 7-year MACRS

n

1
2
3
4
5
6
7
8

Dn

Cum. Dn

Bn

$12,718

$76,282

$12,718

$21,796
$15,566

$54,486
$38,920

$34,514
$50,080

$11,116

$27,804

$61,196

$7,948
$7,939

$19,856
$11,917

$69,144
$77,083

$7,948

$3,969

$85,031

$3,969

$0

$89,000

Page | 9

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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(c) Trade-in allowance

Book value of the old equipment (B3)

$38,920

Less: Trade-in allowance

$20,000

Unrecognized loss

($18,920)

Cost of new equipment

Plus: Unrecognized loss on trade-in
Cost basis of new equipment

$92,000
$18,920
$110,920

Comments: If the old equipment were sold on the market (instead of trade-in),
there would be no unrecognized loss. In that situation, the cost basis for the new
equipment would be just $92,000. No half-year convention is assumed in this
analysis.

Depletion
9.30
(a)
z Ore mine:

Depletion rate per ton =

$8,900, 000 $1,500, 00

= $1.85 per ton
4, 000, 000

z Mining equipment:

Depreciation rate per ton =

$2,500, 000
= $0.625 per ton
4, 000, 000

(b)
z For tax year 2009:

Depletion expense = $1.85(550,000) = $1,017,500

Depreciation expenses = $0.625(550,000) = $343,750
z For tax year 2010:

Depletion expense = $1.85 (688,000) = $1,272,800

Depreciation expenses = $0.625 (688,000) = $430,000

9.31

$600, 000
= $88, 235.29 per MBF
6.8
Total depletion allowance = $88, 235.29(1.5) = $132,352.94

Depletion allowed per MBF =

Page | 10

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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9.32 Percentage depletion versus cost depletion:

Gross Income
Depletion
Computed % depletion

$48,365,000
15%
$7,254,750

Percentage depletion:
Gross Income
Expenses

$48,365,000
$22,250,000

Taxable income
Deduction limit

$26,115,000
50%
$13,057,500

Maximum depletion deduction

The allowable percentage deduction is $7,254,750.

Cost depletion =

$80, 000, 000

(52, 000) = $8,320, 000
500, 000

The cost depletion is more advantageous than the percentage depletion.

9.33
(a) Cost basis:
z Parcel A:

$39, 000, 000

= $4.33 per bbl
9, 000, 000

z Parcel B:

$24, 000, 000

= $4.80 per bbl
5, 000, 000

(b) Depletion charge for parcel A:

z Cost depletion: $4.33(1, 200, 000) = $5, 200, 000
z Percentage depletion:
Gross income = $60 1,200,000 = $72,000,000
Gross Income
$72,000,000
Depletion
15%
Computed % depletion
$10,800,000

Gross Income
Expenses

$72,000,000
$3,600,000

Taxable income
Deduction limit

$68,400,000

Maximum depletion deduction

$34,200,000

50%

Page | 11

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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The allowable percentage deduction is $10,800,000.

(c) Percentage depletion versus cost depletion for parcel A in year 2010:
zCost depletion: $4.33(1, 000, 000) = $4,330, 000
z Percentage depletion:
- Gross income = $75 1,000,000 = $75,000,000

Gross Income
Depletion
Computed % depletion

$75,000,000
15%
$11,250,000

Gross Income
Expenses

$75,000,000
$3,600,000

Taxable income
Deduction limit

$71,400,000
50%

Maximum depletion deduction

$35,700,000
The allowable percentage deduction is $11,250,000.
(d) Percentage depletion versus cost depletion for parcel B in year 2010
zCost depletion: $4.80(800, 000) = $3,840, 000
z Percentage depletion:
Gross income = $75 800,000 = $60,000,000

Gross Income
Depletion
Computed % depletion

$60,000,000
15%
$9,000,000

Gross Income
Expenses

$60,000,000
$3,000,000

Taxable income
Deduction limit

$57,000,000
50%

Maximum depletion deduction

$28,500,000
The allowable percentage deduction is $9,000,000.
During year 2010, Oklahoma Oil claimed its depletion deduction in the amount of
$9,000,000 from parcel B.
Page | 12

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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Book value of $15,000,000 ($24,000,000-$9,000,000) is at the beginning of year

2011. The revised cost per bbl is
$15, 000, 000
= $3.75 per bbl
4, 000, 000
Since no gross income figure is available during year 2011, we may calculate the
depletion charge based on unit cost
$3.75(1, 000, 000) = $3, 750, 000

9.34
(a) Cost depletion:
$30, 000, 000
= $4.6154 per ton
6,500, 000
Depletion cost = $4.6154(1, 000, 000) = $4, 615, 400
Cost per ton =

(b) Percentage depletion:

Gross Income
Depletion
Computed % depletion

$15,000,000
10%
$1,500,000

Gross Income
Expenses

$15,000,000
$1,850,000

Taxable income
Deduction limit

$13,150,000

Maximum depletion deduction

50%

$6,575,000

The allowable percentage deduction is $1,500,000.

Revision of Depreciation Rates

9.35
(a) D = $800, 000 / 25 = $32, 000
(b) B = $400, 000 + $125, 000 = $525, 000
(c)

n=

$800, 000 $400, 000

= 12.5
$32, 000
Page | 13

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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Remaining years = (25 - 12.5) + 10 = 22.5 years

D = $525, 000 / 22.5 = $23,333

(d) Depreciation rate for 12.5 years (June of 12th year) : 2.5641%
D12.5 = ( $800, 000 + $125, 000 ) (0.025641) = $23, 718

9.36
(a) Book depreciation amount for 2010:

B2008 = $180, 000 3($18, 000)

= $126, 000
revised depreciation basis = $126, 000 + $45, 000
= $171, 000
revised useful life = 12 years
D2010 = $171, 000 /12 = $14, 250
(b) Tax depreciation amount for 2010:
z Depreciation schedule for the original machine:

D2010 = $180, 000(0.0892) = $16, 056

zDepreciation schedule for the improvement (treated as a separate MACRS
property):

D2010 = $45, 000(0.1749) = $7,870.5

Total tax depreciation for 2006: D2010 = $16, 056 + $7,870.5 = $23,926.5

9.37 Given: Cost basis = $85,000 + $4,500 = $89,500

(a) Book depreciation schedule (Depreciation basis = $89,500)
n

2008
2009
2010
2011

Dn

Bn

Cum. Dn

$10,688

$78,813

$10,688

$10,688
$10,688
$10,688

$68,125
$57,438
$46,750

$21,375
$32,063
$42,750

Page | 14

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
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(b) Tax depreciation schedule (Depreciation basis = $89,500)

n

2008
2009
2010
2011

Dn

Cum. Dn

Bn

$12,790

$76,710

$12,790

$21,919
$15,654
$11,179

$54,792
$39,138
$27,960

$34,708
$50,362
$61,540

Comments: The accessories costing $5,000 that were incurred in 2006 do not
change the depreciation schedule, because these neither extended the machines
life nor resulted in any additional salvage value.

Corporate Tax Systems

9.38 Net income calculation:
Gross income
Expenses:
Salaries
Wages
Depreciation
Loan interest
Taxable income
Income taxes

35,000,000

$
$
$
$
$
$

6,000,000
7,000,000
800,000
150,000
21,050,000
7,367,499

Net income

13,682,501

Note: Income taxes = $6,416,666+0.35(21,050,000-$18,333,333) = $7,367,499

9.39
(a) Taxable income = $8,500,000 - $2,280,000 - $456,000 = $5,764,000
(b) Income tax calculation using tax formula
(c)
Income taxes = $113,900 + 0.34(5,764,000 - 335,000) = $1,959,760

Page | 15

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
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storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

9.40
(a) Income tax liability:
Gross revenues
Expenses:
Manufacturing
Operating
Interest

$ 3,500,000
$
$
$

Taxable operating income

Adjustment: loss

$ 2,490,000
$
15,000

Taxable income
Income taxes

$ 2,475,000
$ 841,500

Net income

$ 1,633,500

650,000
320,000
40,000

Note 1: Book loss = $60,000 - $75,000 = ($15,000)

Note 2: Income taxes = $113,900+0.34($2,475,000-$335,000) = $841,500
(b) Operating income:
Taxable operating income
Income taxes

$ 2,490,000
$ 846,600

Net operating income

$ 1,643,400

Gains or Losses
9.41

Allowed depreciation = $200, 000(0.1429 + 0.2449 + 0.1749 + 0.1249 / 2)

= $125, 030
Book value = $200, 000 $125, 030
= $74,970
Gain = $120, 000 $74,970 = $45, 030
Net proceeds = $120, 000 $45, 030(0.4)
= $101,988

9.42 (a) Disposed of in year 3:

Allowed depreciation = $80, 000(0.20 + 0.32 + 0.192 / 2)
= $49, 280
Book value = $80, 000 $49, 280
= $30, 720
Loss = $40, 000 $30, 720 = $9, 280

Page | 16

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b) Disposed of in year 5:

Allowed depreciation = $80, 000(0.20 + 0.32 + 0.192 + 0.1152 + 0.1152 / 2)
= $70, 7848
Book value = $80, 000 $70, 7848
= $9, 216
Taxable gains = $30, 000 $9, 216 = $20, 784
(c) Disposed of in year 6:

Allowed depreciation = $80, 000

Book value = $0
Taxable gains = $10, 000

9.43

Allowed depreciation = $350, 000(0.1429 + 0.2449 + 0.1749

+0.1249 + 0.0893 / 2)
= $256, 288
Book value = $350, 000 $256, 288
= $93, 713

(a) If sold at $20,000:

Loss = $20, 000 $93, 713 = ($73, 713)
Loss credit = $73, 713(0.34) = $25, 062
(b) If sold at $99,000:
Gain = $99, 000 $93, 713 = $3, 713
Gains tax = $3, 713(0.34) = $1, 262

9.44
Allowed depreciation = $50, 000(0.2 + 0.32 + 0.192 + 0.1152 / 2)
= $38, 480
Book value = $50, 000 $38, 480
= $11,520

Page | 17

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
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9.45 Given: I = $80,000, S = $20,000, N = 8 years.

(a) Book value on December 31, 2012 using SL depreciation method
n

2010
2011
2012

Dn

Bn

Cum. Dn

$7,500

$72,500

$7,500

$7,500
$7,500

$65,000
$57,500

$15,000
$22,500

(b) Depreciation amount for 2012 using DDB

n

2010
2011
2012

Dn

Bn

Cum. Dn

$20,000

$60,000

$20,000

$15,000
$11,250

$45,000
$33,750

$35,000
$46,250

(c) Optimal time to switch: year 2014.

SL Method
n

2010
2011
2012
2013
2014

Dn

Bn

Cum. Dn

$7,500

$72,500

$7,500

$7,500
$7,500
$7,500

$65,000
$57,500
$50,000

$15,000
$22,500
$30,000

$7,500

$42,500

$37,500

DDB Method
n

2010
2011
2012
2013
2014

Dn

Bn

Cum. Dn

$20,000

$60,000

$20,000

$15,000
$11,250
$8,438

$45,000
$33,750
$25,313

$35,000
$46,250
$54,688

$6,328

$18,984

$61,016

Page | 18

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(d) Taxable gain

Allowed depreciation = $80, 000(0.1429 + 0.2449 + 0.1749 + 0.1249 / 2)
= $50, 012
Book value = $80, 000 $50, 012
= $29,988
Taxable gains = $38, 000 $29,988 = $8, 012

Marginal Tax Rate in Project Evaluation

9.46
(a) Economic depreciation for the milling machine
$200, 000 $50, 000 = $150, 000
(b) Marginal tax rates with the project:

$80,000

$28,580

Taxable
income
$51,420

$80,000

$48,980

$31,020

$456,020

34%

$80,000

$34,980

$45,020

$470,020

34%

$80,000

$24,980

$55,020

$480,020

34%

$80,000

$17,860

$62,140

$487,140

34%

$80,000

$8,920

$71,080

$496,080

34%

Revenue

Dn

Combined
Marginal
income
rate
$476,420
34%

(c) Average tax rates

n
1
2
3
4
5
6

Combined income
$476,420
$456,020
$470,020
$480,020
$487,140
$496,080

Combined income taxes

$161,982.80
$155,046.80
$159,806.80
$163,206.80
$165,627.60
$168,667.20

Average tax rate

34%
34%
34%
34%
34%
34%

9.47 Incremental tax rate calculation:

Revenue
Operating costs
Depreciation
Taxable income

Year 1
$220,000
$150,000
$12,000
$58,000

Year 2
$220,000
$150,000
$19,200
$50,800
Page | 19

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Year 1
$650,000
$221,000

Year 2
$650,000
$221,000

Taxable income with project

Income taxes

$708,000
$240,720

$700,800
$238,272

Incremental taxable income

Incremental income taxes
Incremental tax rate (%)

$58,000
$19,720
0.34

$50,800
$17,272
0.34

Taxable income without project

Income taxes

Comment: Note that the marginal tax rates over the project life remain
unchanged because the additional income from the new project is not large
enough to push the company into a higher tax bracket.

9.48

Good

Economic condition
Fair

Poor

Taxable income
Before expansion
Due to expansion
After expansion

$
$
$

2,500,000 $
2,000,000 $
4,500,000 $

2,500,000 $
500,000 $
3,000,000 $

2,500,000
(100,000)
2,400,000

Income Taxes

1,530,000 $

1,020,000 $

816,000

(a) Marginal tax rate

34%

34%

34%

(b) Average tax rate

34%

34%

34%

9.49 Incremental tax calculations:

(a) Additional taxable income due to project:
Year 1

Year 2

Year 3

Annual revenue

$80,000

$80,000

$80,000

Operating cost

$20,000

$20,000

$20,000

Depreciation

$16,665

$22,225

$3,703

Taxable income

$43,335

$37,775

$56,298

Page | 20

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

(b) Additional income tax calculation:

Year 1

Year 2

Year 3

$350,000

$350,000

$350,000

$119,000

$119,000

$119,000

Taxable income with project

Income taxes

$393,335
$133,734

$387,775
$131,844

$406,298
$138,141

Incremental taxable income

Incremental income taxes
Incremental tax rate

$43,335
$14,734
34%

$37,775
$12,844
34%

$56,298
$19,141
34%

Taxable income without

project
Income taxes

(c) Gain taxes:

Total depreciation = $42,593
Book value = $50, 000 $42,593 = $7, 408
Taxable gains = $10, 000 $7, 408 = $2,593
Gain taxes = (0.34)($2,593) = $881

Combined Marginal Income Tax Rate

9.50
(a) Explicit calculation of state income taxes:
State taxable income = $3,500, 000 $1,800, 000 = $1, 700, 000
State income taxes = $1, 700, 000(0.05) = $85, 000
Federal taxable income = $1, 700, 000 $85, 000 = $1, 615, 000
Federal income taxes = $1, 615, 000(0.34) = $549,100
Combined taxes = $85,000+549,100=$634,100

(b) Tax calculation based on the combined tax rate:

Combined tax rate = 0.34 + 0.05 (0.05)(0.34) = 37.3%
Combined taxes = (0.373)($1,700,000) = $634,100

Page | 21

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

9.51
(a) Marginal tax rates:
State taxable income = $6,500, 000 $3, 450, 000 $650, 000
= $2, 400, 000
$193,120
State tax rate =
= 8.05%
$2, 400, 000
Federal taxable income = $2, 400, 000 $193,120 = $2, 206,880

Federal tax rate =

(b)

$332, 000
= 15.04%
$2, 206,880

Combined marginal tax rate = 0.0805 + 0.1504 (0.0805)(0.1504)

= 21.88%

9.52
(a) Additional annual taxable income due to expansion = $30,000
Taxable income in year 1 = $170,000 + $30,000 = $200,000
The marginal tax rate after business expansion is 39%.

(b) Average tax rate after business expansion $61,250/ $200,000 = 30.63%
Note: Income taxes = $22,250+0.39($200,000-$100,000)=$61,250
(c) PW of income taxes:
z Depreciation schedules: depreciation base = $20,000

n
1
2
3
4

MACRS
$ 6,666
$ 8,890
$ 2,962
$ 1,482

Page | 22

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

z Incremental income taxes under 3-year MACRS

Revenue
Expense
Depreciation
Taxable
income
Income taxes
PW(10%)=

Operating Year
Year 1
Year 2
$50,000
$50,000
$20,000
$20,000
$6,666
$8,890

Year 3
$50,000
$20,000
$2,962

$23,334

$21,110

$27,038

$9,100
$22,999

$8,233

$10,545

9.53

n
1
2
3
4
5
6
7
8

Dn

(a) Bn 1

$ 500,150
$ 857,150
$ 612,150
$ 437,150
$ 312,550
$ 312,200
$ 312,550
$ 156,100

$3,500,000
$299,850
$2,142,700
$1,530,550
$1,093,400
$780,850
$468,650
$156,100

(b) Taxes
$42,000
$35,998
$25,712
$18,367
$13,121
$9,370
$5,624
$1,873

Short Case Studies

ST 9.1 Given: I = $82,000 + $3,000 = $85,000, N = 10 years, S = $3,000
Book depreciation expenses for 2004:
$85, 000 $3, 000
D2004 =
= $8, 200
10

Dn

Bn

2004
2005
2006

$8,200
$8,200
$8,200

$76,800
$68,600
$60,400

Page | 23

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Book depreciation expenses for 2007:

New depreciation basis = $60, 400 + $8, 000 = $68, 400

Remaining useful life=10 years
Salvage value = $3, 000
D2007 =

$68, 400 $3, 000

= $6,540
10

Dn

Bn

2007
2008
2009

$6,540
$6,540
$6,540

$61,860
$55,320
$48,780

Book depreciation expenses for 2010:

New depreciation basis = $48, 780 + $5, 000 = $53, 780
Remaining useful life=7 years
Salvage vlaue = $6, 000
D2010 =

$53, 780 $6, 000

= $6,825.71
7

ST 9.2
(a) Depletion basis = $32.5 million - $3 million = $29.5 million
$29,500, 000
= $4.54 per bbl
6,500, 000
Cost depletion for 2009 = $4.54 / bbl 420, 000 bbl = $1,906,800
Cost depletion for 2010 = $4.54 / bbl 510, 000 bbl = $2,315, 400
Depletion allowance per bbl =

(b) Depreciation basis = equipment cost + pipeline cost = $3,360,000

$3,360, 000
= $0.517 per bbl
6,500, 000
Cost depreciation for 2009 = $0.517 / bbl 420, 000 bbl = $217,140
Cost depreciation for 2010 = $0.517 / bbl 510, 000 bbl = $263, 670
Depreciation allowance per bbl =

Page | 24

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

ST 9.3
(a) Incremental Operating income:
Year

Revenue
Mfg. Cost
Depreciation
O&M

$15,000,000 $15,000,000 $15,000,000 $15,000,000 $15,000,000

6,000,000
6,000,000
6,000,000
6,000,000
6,000,000
714,500
1,224,500
874,500
624,500
223,250
1,200,000
1,200,000
1,200,000
1,200,000
1,200,000

Taxable Income
Income Tax

7,085,500
2,479,925

6,575,500
2,301,425

6,925,500
2,423,925

7,175,500
2,511,425

7,576,750
2,651,863

Net Income

4,605,575

4,274,075

4,501,575

4,664,075

4,924,888

(b) Gains or losses:

Total depreciation = $3, 661, 250
B5 = $5, 000, 000 $3, 661, 250

= $1,338, 750
Taxable gains = $1, 600, 000 $1,338, 750
= $261, 250

ST 9.4
(a) If Diamond invests in the facilities and markets the product successfully, the
expected tax rate in each year will remain at 34%. Since the local and state
taxes are tax-deductible expenses on federal tax calculation purpose, the
combined marginal tax rate is

tm = 0.34 + 0.05 (0.05)(0.34) = 37.3%

(b) Gains or losses

Plant (39-year MACRS):

Total depreciation = (2.4573% + 2.5641% + " + 2.4573%)($10, 000, 000)

= $2, 029,913
B8 = $10, 000, 000 $2, 029,913
= $7,970, 087
Losses = $6, 000, 000 $7,970, 087
= ($1,970, 087)
Page | 25

Contemporary Engineering Economics, Fifth Edition, by Chan S. Park. ISBN: 0-13-611848-8

2011 Pearson Education, Inc., Upper Saddle River, NJ. All rights reserved.
This material is protected by Copyright and written permission should be obtained from the publisher prior to any prohibited reproduction,
storage in a retrieval system, or transmission in any form or by any means, electronic, mechanical, photocopying, recording, or likewise.
For information regarding permission(s), write to: Rights and Permissions Department, Pearson Education, Inc., Upper Saddle River, NJ 07458.

Equipment (7-year MACRS):

Total depreciation = $40, 000, 000
B8 = 0

Ordinary gains = $4, 000, 000

Net gains:

Net gains = $4, 000, 000 $1,970, 087

= $2, 029,913
Gains tax(37.3%) = $2, 029,913 0.373
= $757,158
Net proceeds from sales = $9, 000, 000 $757,158
= $8, 242,842
(c) Net operating income
Income Statement (all units in thousand dollars)
n

1
$30,000

2
$30,000

3
$30,000

4
$30,000

5
$30,000

6
$30,000

7
$30,000

8
$30,000

9,000
12000

9,000
12000

9,000
12000

9,000
12000

9,000
12000

9,000
12000

9,000
12000

9,000
12000

246
5716

256
9796

256
6996

256
4996

256
3572

256
3568

256
3572

246
1784

Taxable Income for State

State Income taxes (5%)
Taxable Income for Federal
Federal Income taxes (34%)

$3,038
152
$2,886
981

($1,052)
-53
($999)
-340

$1,748
87
$1,661
565

$3,748
187
$3,561
1,211

$5,172
259
$4,913
1,671

$5,176
259
$4,917
1,672

$5,172
259
$4,913
1,671

$6,970
349
$6,622
2,251

Net Income

$1,905

($660)

$1,096

$2,350

$3,243

$3,245

$3,243

$4,370

Revenue
Expenses :
Mfg. cost
Operating cost
Depreciation
Building
Equipment

Corporate operating losses: Ordinary operating losses (say,

year 2) can be carried back to each of the preceding 3 years and
forward for the following 15 years, and can be used to offset
taxable income in those years. In our example, the taxable income
during the first year is large enough to offset the operating loss
during the second year, so that the corporation wil get a federal tax refund
in the amount of $ 340,000 plus $53,000 (state tax refund) at the end of year 2.

Page | 26