C2: Nov 2000 #45

[VernSchil]

Could someone please tell me how we're supposed to infer that the sentence "You have been asked by senior management to set up the tax savings of 17,500 at an annual tax rate of 35%" means that PV of the sum of the depreciation charges equals 17,500/.35 ? Where in the reading does it equate tax savings with total depreciation? Thanks.

[Bama Gambler]

Originally Posted by LPorter33

Could someone please tell me how we're supposed to infer that the sentence "You have been asked by senior management to set up the tax savings of 17,500 at an annual tax rate of 35%" means that PV of the sum of the depreciation charges equals 17,500/.35 ? Where in the reading does it equate tax savings with total depreciation? Thanks.

Problems like these are used to distinguish the 9s from the 10s (and the 5s from the 6s - read on). Unfortunately, many people cannot bring themselves to skip these problems during their studies. They waste a lot time worrying about these problems, and in return neglect the more straightforward problems, ultimately ending up with a 5 instead of a 6. In short, don't worry about this problem. There are a couple of these on every test. Take your 1 out of 5 chances and move on to an easy problem.


Bama Gambler

[Avi]

Here is the solution I posted on the casact list.

OK, got it now. The trick in the problem (at least to me) is to realize that senior management wants a tax savings whose PRESENT VALUE is $17,500 at 8%.

Here goes:

The tax savings is the present value of the tax shields provided at 8% where the corporate tax rate is 35%.

The tax shield is provided by the depreciation amounts, so the tax savings are 35% of the depreciation amounts.

For SOY, the depreciation at time t (where the life is n) is t/[n*(n+1)/2]*(A-S)

DRAW A TIMELINE!!!!

You will see that the cashflows of the Tax Shield of the payments become:

.35*(20/210)*(A-S)/1.08 + .35*(19/210)*(A-S)/(1.08^2) + ........

OR

17,500 = (Da)[20,.08]/210 * .35 * (A-S) or

(17,500 * 210)/(.35 * (Da)[20,.08]) = 110,000 -S or

S = 110,000 - (17,500 * 210)/(.35 * (Da)[20,.08])

Now (Da)[20,.08] = 127.27 so

S = 110,000 - (3675000/44.55)

S = 110,000 - 82499.72

S = 27,500.28 or $27,500

--Avi





"Somebody Me"
<april98763@hotma
il.com>


To: "Study Group 2" <studygroup2@lists.casact.org>
10/21/2002 10:38 cc:
AM Subject: [studygroup2] more interest theory
Please respond to
"Study Group 2"






OK I have yet another Interest Theory problem for you all, this is from an
old exam:

"A machine has been purchased by a company for 110,000. The asset will be
depreciated over 20 years using the sum-of-digits method. You have been
asked by senior management to set up the tax savings of 17,500 at an annual

tax rate of 35% and an annual interest rate of 8%. Calculate the salvage
value."

My problem here is figuring out what to do with the tax savings and how
that
relates to doing a depreciation calculation. I am missing something
because
I don't even know where to begin with this. Thanks for any help!




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[c3 taker]

Originally Posted by Bama Gambler

Problems like these are used to distinguish the 9s from the 10s (and the 5s from the 6s - read on). Unfortunately, many people cannot bring themselves to skip these problems during their studies. They waste a lot time worrying about these problems, and in return neglect the more straightforward problems, ultimately ending up with a 5 instead of a 6. In short, don't worry about this problem. There are a couple of these on every test. Take your 1 out of 5 chances and move on to an easy problem.


Bama Gambler

This was definately a problem that I had no idea how to solve when I first saw it. I would probably skip it and if I had time at the end come back and give it a shot like Bama Gambler suggests. I think the important thing to remember here is that the sum of digits depreciation method follows a Decreasing annuity and therefore can be done in a more "interest theory" type of way rather than the normal "plug and chug" interest theory problems.