Engineering Economy

Chapter 8: Depreciation

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
The objective of Chapter 8 is to
explain how depreciation affects
income taxes, and how income
taxes affect economic decision
making.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Depreciation is the decrease in value of
physical properties with the passage of
time.
• It is an accounting concept, a non-cash cost,
that establishes an annual deduction against
before-tax income.
• It is intended to approximate the yearly
fraction of an asset’s value used in the
production of income.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Property is depreciable if
• it is used in business or held to produce
income.
• it has a determinable useful life, longer than
one year.
• it is something that wears out, decays, gets
used up, becomes obsolete, or loses value
from natural causes.
• it is not inventory, stock in trade, or
investment property.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Depreciable property is

• tangible (can be seen or touched; personal

or real) or intangible (such as copyrights,
patents, or franchises).
• depreciated, according to a depreciation
schedule, when it is put in service (when it
is ready and available for its specific use).

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Straight line (SL): constant amount of
depreciation each year over the
depreciable life of the asset.

• N = depreciable life • BVk = book value at

• B = cost basis end of k
• dk = depreciaton in k • SVN = salvage value

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Suppose you have a laptop
costing Rs. 100000, which has
useful life of 5 years and no
salvage value.
Year BVn-1 Dep BVn
0 100000 - 100000
1 100000 20000 80000
2 80000 20000 60000
3 60000 20000 40000
4 40000 20000 20000
5 20000 20000 0

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Suppose you have a laptop
costing Rs. 100000, which has
useful life of 5 years and 20000
salvage value.
Year BVn-1 Dep BVn
0 100000 - 100000
1 100000 16000 84000
2 84000 16000 68000
3 68000 16000 52000
4 52000 16000 36000
5 36000 16000 20000

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Pause and solve
Acme purchased a coordinate measurement
machine (CMM). The cost basis is $120,000 and it
has a seven year depreciable life. Acme estimates a
salvage value of $22,000 at the end of seven years.
Determine the annual depreciation amounts using
SL depreciation. Tabulate the annual depreciation
amounts and book value of the CMM at the end of
each year.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
On 1st July, 2008 a company purchased a machine
for Rs 3,90,000 and spent Rs 10,000 on its
installation. The useful life of the machine is 8 years.
On 30th November, 2011 the machine was
dismantled at a cost of Rs 5,000 and then sold for Rs
1,00,000. On 1st December, 2011 the company
acquired and put into operation a new machine at a
total cost of Rs 7,60,000 with the useful life of 10
years. The company closes its books of account
every year on 31st December. Calculate the
depreciation for 5 years using the straight line
method.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 Date BVn-1 Depn BVn
2008/12/31 400000 25000 375000
2009/12/31 375000 50000 325000
2010/12/31 325000 50000 275000
2011/11/30 275000 45833 222967
5000
227967
300000

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Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Declining-balance (DB) and DDB: a
constant-percentage on the remaining
BV is depreciated each year.
Depn For Year 1
Depn For Year k
Cumulative Depn For Year k
Book value at Year k

The constant percentage is determined by R,

where R = 2/N when 200% declining balance is
being used, R = 1.5/N when 150% declining
balance is being used.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Declining-balance (DB) and DDB
An implied DB depreciation rate is determined
by
d=
Where,
d = depreciation rate
S = Salvage value
B = Book Value
n = expected life
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
If a salvage value is estimated for the
asset, this estimated S value is not used
in the DB or DDB method to calculate
annual depreciation.
However, if the implied S < estimated S,
it is necessary to stop charging further
depreciation when the book value is at or
below the estimated salvage value.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Pause and Solve

Freepost-McMoRan Copper and Gold has

purchased a new ore grading unit for $80000. The
unit has an anticipated life of 10 years and a
salvage value of $10000. Use the DB and DDB
methods to compare the schedule of depreciation
and book values for each year.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Here, If we need to calculate the DB Depreciation
method with implied salvage value, we have to use
following formula to calculate depreciation rate:

d=

Therefore: d = 0.1877 for implied DB and for DDB

it is 2/N = 2/10 = 0.2

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Pause and Solve

The underwater electro-acoustic transducers were

purchased for use in SONAR applications. The
equipment will be DDB depreciated over an
expected life of 12 years. There is a first cost of
$25000 and an estimated salvage of $2500. a)
Calculate the depreciation and book value for
years 1 and 4. b) Calculate the implied salvage
value after 12 years.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Pause and Solve
A new electric saw for cutting small pieces of
lumber in a furniture manufacturing plant has a
cost basis of $4,000 and a 10-year depreciable
life. The estimated SV of the saw is zero at the
end of 10 years. Use the DB method to calculate
the annual depreciation amounts when

(a) R = 2/N (200% DB method)

(b) R = 1.5/N (150% DB method).

Tabulate the annual depreciation amount and BV

for each year.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 150% 200%

EOY Dk BVk Dk BVk

0 4000 - 4000

1 600 3400 800 3200

2 510 2890 640 2560

3 433.5 2456.5 512 2048

4 368.475 2088.025 409.60 1638.40

5 313.204 1774.82 327.68 1310.72

6 266.22 1508.6 262.14 1048.58

7 226.30 1282.3 209.72 838.86

8 192.35 1089.96 167.77 671.09

9 163.49 926.46 134.22 536.87

10 138.97 787.49 107.37 429.50

Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 The units-of-production method can be
used when the decrease in value of the
assset is mostly a function of use, instead
of time. The cost basis is allocated
equally over the number of units
produced over the asset’s life. The
depreciation per unit of production is
found from the formula below.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Depn per unit of production =

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Switching between Depreciation
Methods
Switching maximizes the present value of
accumulated and total depreciation over the recovery
period.
Therefore, switching usually increases the tax
advantage in years where the depreciation is larger.
Switching from a DB method to the SL method is
the most common switch because it usually offers a
real advantage, especially if the DB method is DDB.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 General rules of switching are:
 Switching is recommended when the depreciation for
year t by the currently used method is less than that
for a new method. The selected depreciation Dt is the
larger amount.
 Only one switch can take place during the recovery
period.
 The book value cannot go below the estimated SV.
Not the DB implied SV is used to compute the
depreciation for the new method; We assume S = 0 in
all cases.
 The undepreciated amount is used to select the larger
Dt for the next switching decision.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Sum of the years digits method
(SOYD)
• This method results in larger than straight
line depreciation charges during the early
years of an asset and smaller charges as the
asset nears the end of its estimated useful
life. Each year depreciation charge is
compound as the remaining useful life at the
beginning of the year divided by the sum of
the years digits for the total useful life.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 SOYD

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Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 Pause and Solve
• Compute the depreciation charge in each
year using SOYD method of depreciation
from the following information given
below.
• Cost of the assets = Rs. 900
• Life of the asset = 5 years
• Salvage value = Rs. 70
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Solution
• Sum of the year digits = 1+2+3+4+5 = 15
1st year SOYD depn = 5/15(900-70) = 277
2nd year SOYD depn = 4/15(900-70) = 221
3rd year SOYD depn = 3/15(900-70) = 166
4th year SOYD depn = 2/15(900-70) = 111
5th year SOYD depn = 1/15(900-70) = 55

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Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Pause and Solve
• Find and tabulate the depreciation of a
machine that cost 5000 and has salvage
value of 500 after 6 years by using SOYD
depreciation method.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Sinking fund depreciation method
In sinking fund, the book value decreases at
increasing rates with respect to the life of the asset.
The loss in value of asset (cost – salvage) is made
available and the form of cumulative depreciation
amount at the end of the asset by setting up an equal
depreciation amount at the end of each period
during the lifetime of asset.
The fixed sum depreciated at the end of every time
period earns an interest at the rate of i%
compounded annually.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Let
P = first cost of the asset
F = Salvage value
N = Life of the asset
i = rate of return compounded annually
A = the annual equivalent amount of depn charge
BVk = the book value of the asset at the end of period k
Dt = the depreciation charge at the end of the period t
To find the annual equivalent amount (A)
A = (P-F)(A/F,i%,N)
To find the depreciation charge (Dt)
D = (P-F)(A/F,i%,N)(F/P,i%,t-1)
To find the book value at the end of period t
T = (P-F)(A/F,i%,N)(F/A,i%,t)
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 Pause and solve
• Compute the depreciation charge and book
value in each year
• Cost of the asset = Rs. 100000
• Salvage value = Rs. 20000
• Life of the asset (N) = 8 years
• Interest rate = 12%

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Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Solution
Annual depreciation charge = (P-F)(A/F,i%,N)=6504
Depn at the end of 1st year (D1) = 6504
Depn at the end of 2nd year (D2) = 6504 + 6504×
0.12=7284.48
Depn at the end of 3rd year (D3) = 6504 + (6504+7284.48)×
0.12=8158.62
Depn at the end of 4th year (D4) = 6504 +
(6504+7248.48+8158.62)× 0.12=9137.65
It will continue till 8th years

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Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
EOY (t) Fixed depn Net depn Book Value
0 - - 100000
1 6504 6504.00 93496.00

2 6504 7284.48 86211.52

3 6504 8158.62 78052.90

4 6504 9137.65 68915.25

5 6504 10234.17 58681.08
6 6504 11462.27 47218.81
7 6504 12837.74 34381.07
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Engineering Economy, Fifteenth Edition
8 6504
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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Upper Saddle River, New Jersey 07458
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 Pause and Solve
• Company Z purchased the machine for
250000, which has a useful life of 7 years
and has salvage value of 25000 at the end of
7th year. Find and tabulate the depreciation
of the machine using sinking fund method if
the interest rate is 8%.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
The Modified Accelerated Cost Recovery
System (MACRS) is the principle
method for computing depreciation for
property in engineering projects. It
consists of two systems, the main system
called the General Depreciation System
(GDS) and the Alternative Depreciation
System (ADS).

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 When an asset is depreciated using
MACRS, the following information is
needed to calculate deductions.
• Cost basis
• Date the property was placed into service
• The property class and recovery period
• The MACRS depreciation method (GDS or
ADS).
• The time convention that applies (half year)
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Using MACRS is easy!

1. Determine the asset’s recovery period (Table 7-

2).
2. Use the appropriate column from Table 7-3 that
matches the recovery period to find the recovery
rate, rk, and compute the depreciation for each
year as

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
• The slides below are related to taxes, which
is not included in the syllabus. Though if
you need in any condition, you can go
through.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 There are many different types of taxes.
• Income taxes are assessed as a function of gross
revenues minus allowable expenses.
• Property taxes are assessed as a function of the
value of property owned.
• Sales taxes are assessed on the basis of purchase
of goods or services.
• Excise taxes are federal taxes assessed as a
function of the sale of certain goods or services
often considered nonnecessities.
We will focus on income taxes.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Taking taxes into account changes
our expectations of returns on
projects, so our MARR (after-tax) is
lower.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 The after-tax MARR should be at least
the tax-adjusted weighted average cost of
capital (WACC).

 = fraction of a firm’s pool of capital

borrowed from lenders
t = effective income tax rate as a decimal
ib = before-tax interest paid on borrowed
capital
ea = after-tax cost of equity capital
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 Depreciation is not a cash flow, but it
affects a corporation’s taxable income, and
therefore the taxes a corporation pays.

Taxable income = gross income

– all expenses except capital invest.
– depreciation deductions.

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Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Federal taxes are calculated using a set
of income brackets. each applying a
different tax rate on the marginal value
of income. State taxes vary widely.
• Tax rates are found in Table 7-5.
• Corporations need to know their effective tax rate,
which is a combination of federal and state taxes
according to either formula below.

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Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 Pause and solve

Last year Acme, Inc. had $16.4 million in revenue, $1.2

million of operating expenses, and depreciation expenses of
$5.4 million. Using the corporate federal tax rates from the
table provided, what is the approximate federal tax this
corporation will have to pay for this tax year?

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Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 The disposal of a depreciable asset can
result in a gain or loss based on the sale
price (market value) and the current book
value

A gain is often referred to as depreciation recapture,

and it is generally taxed as the same as ordinary
income. A loss is a capital loss. An asset sold for
more than it’s cost basis results in a capital gain.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 Pause and solve
Acme Casting and Molding sold a piece of equipment
during the current tax year for $67,000. This equipment had
a cost basis of $210,000 and the accumulated depreciation
was $153,000. Assume the effective income tax rate is
40%. Based on this information, what is

a.the gain (loss) on disposal,

b.the tax liability (or credit) resulting from this sale, and
c.the tax liability (or credit) if the accumulated depreciation
was $125,000 instead of $153,000?

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Engineering Economy, Fifteenth Edition
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By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 After-tax economic analysis is
generally the same as before-tax
analysis, just using after-tax cash
flows (ATCF) instead of before-
tax cash flows (BTCF). The
analysis is conducted using the
after-tax MARR.
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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Cash flows are typically determined for
each year using the notation below.
Rk = revenues (and savings)
from the project during period k
Ek = cash outflows during k
for deductible expenses
dk = sum of all noncash, or
book, costs during k, such as
depreciation
t= effective income tax rate on
ordinary income
Tk = income tax consequence
during year k
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ATCFk =ATCF from the project during year k
Engineering Economy, Fifteenth Edition
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
Upper Saddle River, New Jersey 07458
All rights reserved.
 Some important cash flow formulas.
Taxable income

Ordinary income tax consequences

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Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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Insert Figure 7-4 on this slide

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Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
Acme purchased a pump for $250,000 and
expended $20,000 for shipping and
installation. The addition of this pump will
result in an increase in revenue of $80,000,
with associated increased expenses of
$10,000, each year. The pump has a GDS
recovery period of five years, and Acme’s
effective tax rate is 41%. What is the ATCF
for this project for the fourth year of service
of the asset?
Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
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 Copyright ©2012 by Pearson Education, Inc.
Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
 Economic value added, EVA, is an
estimate of the profit-earning potential of
proposed capital investments in
engineering projects. It is the difference
between a company’s adjusted net
operating profit after taxes (NOPAT) in a
particular year and its after-tax cost of
capital during that year.

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
where,

and

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.
For Acme, what is the EVA for year 4 if
their after-tax MARR is 8%?

Copyright ©2012 by Pearson Education, Inc.

Engineering Economy, Fifteenth Edition
Upper Saddle River, New Jersey 07458
By William G. Sullivan, Elin M. Wicks, and C. Patrick Koelling
All rights reserved.