First American is considering buying a new machine to increa

First American is considering buying a new machine to increase production. It will cost $3,000. Shipping will be $300. It has a three-year class life. At the end of one year they plan to sell the machine for $2,000. The new machine will allow FA to increase revenues by $1,800 each year but expenses will increase by $400 each year. If the new machine is purchased, inventory will decrease by $1,000 and accounts payable will increase by 350. Straight-line depreciation will be used. FA\'s marginal tax rate is 34% and its cost of capital is 7%.

What is the depreciation for years 1 – 4?

$1,100; $1,100; $1,100; 0

$325; $650; $650; $325

$775; $1,550; $1,550; $775

$550; $1,100; $1,100; $550

Solution

Depreciation per year = cost / useful life = 3300/3 = 1100 per year

But according to half year convention only half of the depreciation is allowed in year 1 and the last year.

Year 1 depreciation = 1100* 50% = 550

Year 2 & year 3 depreciation = 1100

Year 4 depreciation = 550