MIE 754 Manufacturing

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MIE 754 - Class 7 Manufacturing Engineering
Economics

• No Class Meeting this Thurs (10/4/01)
• Concerns and Questions
• Quick Recap of Previous Class
• Todays Focus
• Chapter 6 Depreciation (continued) and Taxes
• Assignment 1 - Graded Due in 2 Weeks
• Refer to course web site for instructions and
  materials
• Homework Problems Due in 1 Week (next pg)

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Concerns and Questions?

• No Class Meeting this Thurs (10/4)
• Homework Due in 1 Weeks
• Chap 3 - 5, 9, 14, 19, 21, 23
• Chap 4 - 6(a), 12, 16, 26(IRR only)
• Chap 6 - 6(a, c, d), 17(c), 20, 25, 30
• Homework and Assignment Tracking

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Quick Recap of Previous Class

• Internal Rate of Return
• Comparing Alternatives
• Basic Rule and Steps
• Depreciation
• What is it? Why bother?
• Straight Line
• Declining Balance

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Straight Line Method

• A constant amount is depreciated each year over
  the asset's life.
• dk (B - SVN) / N for k 1, 2, ..., N (6-1)
• dk k(dk) for 1 ? k ? N (6-2)
• BVk B - dk (6-3)

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Declining Balance Method

• Annual depreciation is a constant percentage of
  the asset's value at the BOY.
• d1 B(R) (6-4)
• dk B(1-R)k-1(R) BVk-1(R) (6-5)
• dk B1 - (1 - R)k (6-6)
• BVk B(1 - R)k (6-7)
• BVN B(1 - R)N (6-8)
• R 2/N 200 declining balance, or
• R 1.5/N 150 declining balance
• Uses the useful life (or class life) for N
• Does not consider SVN

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SL and DB Example

• A computer was purchased for 20,000 and 2,000
  was spent installing it. The computer has an
  estimated salvage value of 4,000 at the end of
  its class life. Compute the depreciation
  deduction in year 3 and the book value at the end
  of year 6 using
• a) straight-line method
• b) 200 declining balance method

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• Step 0. Compute the Cost Basis (B) B
  20,000 2,000 22,000
• Step 1. Determine the Class Life From Table
  6-2, N 6 years
• Straight Line Method
• BV6 B - dk 22,000 - (6(3,000)) 4,000

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200 Declining Balance

• R 2/6 1/3 0.33
• d3 B (1-R)k-1(R) 22,000(0.67)2(0.33) 3,259
• BV6 B (1-R)k 22,000(0.67)6 1,931
• d6 22,0001-(1-0.33)6 20,069
• Note BV6 B - d6 22,000 - 20,069 1,931

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SL and DB Comparison
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MACRS (GDS) METHOD

• Annual depreciation is a fixed percentage of the
  cost basis (percentage specified by the IRS).
  Mandatory for most assets.
• dk rkB
• Step 1. Determine the property class (recovery
  period) from Table 6-2 or Table 6-3
• Step 2. Use Table 6-4 to obtain GDS rates, rk
• Step 3. Compute depreciation deduction in year k
  by multiplying the assets cost basis by the
  appropriate recovery rate, rk.
• Remember MACRS is spread over N 1 years due to
  half-year convention

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Previous Example by MACRS Method

• Step 0. Compute the Cost Basis (B) for the
  Computer B 20,000 2,000 22,000
• Step 1. Determine the Property Class (Recovery
  Period) From Table 6-2 5 year Recovery Period
• Steps 2 and 3 shown in the following table

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Previous Example with MARCS
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Example

• The La Salle Bus Company has decided to purchase
  a new bus for 85,000, with a trade-in of their
  old bus. The old bus has a trade-in value of
  10,000. The new bus will be kept for 10 years
  before being sold. Its estimated salvage value
  at that time is expected to be 5,000.
• Compute the following quantities using (a) the
  straight-line method, (b) the 200 declining
  balance method, and (c) the MACRS method.
• depreciation deduction in the first year and the
  fourth year
• cumulative depreciation through year four
• book value at the end of the fourth year

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• First, calculate the cost basis.
• B 10,000 85,000 95,000
• Next, determine the depreciable life.
• From Tables 6-2 and 6-3the class life 9 years
  and the GDS recovery period 5 years for buses.

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Example Straight-Line Method

• Assume SV9 5,000
• dk (95,000-5,000)/9 10,000/yr for k 1 to 9
• 1. d1 d4 10,000
• 2. d4 4 (10,000) 40,000
• 3. BV4 B - d4 95,000 - 40,000 55,000

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Example 200 Declining Balance Method
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Example MACRS Method
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After-Tax Cash Flow Analysis (Fig 6-4)
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After-Tax Cash Flow Analysis (Fig 6-4)
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An after-tax evaluation of a project's after-tax
cash flows requires an after-tax MARR
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When an asset is disposed of for more (less) than
its book value, the resulting gain (loss) is taxed

• Depreciation recapture and capital gains (losses)
  are taxed as ordinary income.
• Capital Gain (Loss) MV - BV
• If an asset is sold for less than its current
  book value (MV lt BV), it is termed a capital
  loss, and taxes on the loss represent a tax
  credit.

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Example
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Develop ATCF for Example
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Is Investment Worthwhile?
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Looking Closer at Year 4
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Lease vs. Purchase Example

• Determine the more economic means of acquiring a
  copier in your business if you may either (a)
  purchase the copier for 5,000 with a probable
  resale value of 1,000 at the end of 5 years or
  (b) rent the copier for an annual fee of 900 per
  year for 5 years with an initial deposit of 500
  refundable upon returning the copier in good
  condition. If you own the copier, you will
  depreciate it by using the MACRS method (class
  life of 5 years). All rental fees are deductible
  for income tax purposes. As the owner or lessee,
  you will pay all expenses associated with the
  operation of the copier. A deposit does not
  affect taxes when paid out or received back.
• Compare these alternatives by using the
  equivalent uniform annual cost method. The
  after-tax MARR is 10 per year, and the effective
  income tax rate is 40.

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Option A - Purchase Copier
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Option A - Purchase Copier
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Option B - Rent Copier
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