Don Burnette is starting a new home planning business. For years, people have asked Don to draw up the blueprints for their homes and he has done so in his spare time. Don has decided to go into business full time and believes that he will need to add one new draftsman each year for the next five years as his business grows. Don believes that the best way to design homes is by using home designing software on a computer. Thus, he plans to buy himself a new computer and a computer for each new associate who joins the company.

Don has heard that using MACRS for tax purposes will save him taxes and has asked you to develop a schedule illustrating the depreciation expense that would be recognized using straight-line depreciation for his income statement and MACRS depreciation for his tax return over the next eight years under the following assumptions:

1. Don will start his business on July 1, 20-1, and will purchase a new computer on that date.

2. Don will hire four new associates, one on July 1 of each year for the next four years, 20-2 through 20-5. He will also buy each associate a computer.

3. The computers cost $4,000, have useful lives of five years, and have no salvage value. Don will take a half-year’s depreciation in the first and last year of each computer’s life when computing straight-line depreciation. He will use the MACRS rates, which also assume a half-year convention in the first and last years of the asset’s life.

4. As each computer completes its five-year life, Don will buy a new one to replace it.

5. Don’s tax rate is 30%.

REQUIRED

1. Prepare a depreciation schedule showing the straight-line depreciation expense for years 20-1 through 20-8.

2. Prepare a depreciation schedule showing the MACRS depreciation for years 20-1 through 20-8. The MACRS rates are shown below.

Depreciation Rates for Five-Year Assets

MACRS Depreciation

Year    MACRS

1          20.0%

2          32.0

3          19.2

4          11.5

5          11.5

6         5.8

100.0%

3. Compute the difference between straight-line depreciation and MACRS depreciation for each year, 20-1 through 20-8.

4. The differences in part (3) represent the differences in Don’s taxable income each year. By using MACRS, how much does Don save in taxes each year, and in total?

5. Under what conditions would Don lose the accumulated tax savings?