CMA Study Group

Cap Budget Macrs half year convention rule

  • 1.  Cap Budget Macrs half year convention rule

    Posted 15 days ago

    Owen Eyewear is planning to purchase a $520,000 computer system to improve the quality and lead time of its eyewear production. Management estimates that this investment will result in increased annual cash revenues of $280,000 with related operating costs of $57,000. The computer system will be depreciated by the Modified Accelerated Cost Recovery System (MACRS) over a five-year life with no salvage value; however, Owen expects to sell the computer system at the end of Year 5 for $70,000. Determine the net present value (NPV) of this investment opportunity.

    Assume a 30% income tax rate and a 12% hurdle rate. Also assume that the asset will be placed in service at the beginning of the fiscal year.

    MACRS Rates: Year 1, 20.0%; Year 2, 32.0%; Year 3, 19.2%; Year 4, 11.52%; Year 5, 11.52%; Year 6, 5.76%

    Ans : $186198

    Year of sale is end of 5th year, my understanding says depreciation should be full 11.52 % which is 5,20,000 * 11.52%
    but the explanation mentions this : **Because the asset was sold before Year 6, under the MACRS half-year convention rule, only half of the depreciation is taken in the year of sale; in this case, it is $29,952. This means that the book value of the computer system at the end of Year 5 is $59,904 ($520,000 purchase price − $460,096 accumulated depreciation [$104,000 + $166,400 + $99,840 + $59,904 + $29,952])

    My question is why half of depreciation has been taken in consideration when the problem clearly states it was sold end of the 5th year
    second question : what would be the treatment of depreciation had the sale taken place on 4th or 6th year. should we deduct half of depreciation even if the sale is on 6th year or 4th year. or this half year convention rule is only when the asset is sold one year before hitting its full depreciation.

    Kirti Sheth