Accounting for tax-savings due to annual depreciation

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Reference no: EM131929534

1. Projected ownership of 4 years.

2. Rental revenues before taxes of $600,000 at EOY1 decreasing thereafter at an annual rate of 1.0%.

3. Annual expenses of $400,000 at EOY1 increasing thereafter at an annual rate of 1.0%.

4. Today’s asking price for the building is $800,000 with an expected selling price of $900,000 in 4 years.

5. The Canadian income tax rate on this type of investment is assumed to be 50% (on profits before taxes, capital gains or losses, terminal losses and on recaptured depreciation).

6. Buildings and equipment are to be depreciated using the DB method with a 10% depreciation rate.

7. The half-year rule applies to the depreciation of the building.

8. Working capital = $0.

9. You will need a $500,000 loan at a 10% rate which will be repaid as follows: • EOY1 = 0% of the total loan • EOY2 = 25% • EOY3 = 35% • EOY4 = 40%

10. The annual inflation rate is 2.0%.

11. MARRs are:

• Before-taxes with inflation = 10%

• Before-taxes without inflation (inflation-free) = 8%

• After-taxes with inflation = 5%

• After-taxes without inflation (inflation free) = 3%

Question:

1. If the initial cost of the rental building is $800,000 (before accounting for the impact of annual depreciation on income taxes), what would be its after-tax initial cost (nearest $100) (after accounting for tax-savings due to annual depreciation? a) 607,400; b) 677,000; c) 704,000; d) 713,000.

Reference no: EM131929534

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