This exercise uses the Northeast data from S7-5. Assume Northeast is trying to decide which depreciation method to use for income tax purposes. The company can choose from among the following methods: (a) straight-line, (b) units-of-production, or (c) double-declining-balance methods.

1. Which depreciation method offers the highest tax advantage for the first year? Describe the nature of the tax advantage.

2. How much income tax will Northeast save for the first year of the airplane’s use under the method you just selected as compared with using the straight-line depreciation method? The company’s income tax rate is 34%. Ignore any earnings from investing the extra cash.

Data from S7-5

On January 1, 2017, Northeast Transportation Company purchased a used aircraft at a cost of $58,900,000. Northeast expects the plane to remain useful for five years (7,200,000 miles) and to have a residual value of $4,900,000. Northeast expects to fly the plane 750,000 miles the first year, 1,375,000 miles each year during the second, third, and fourth years, and 2,325,000 miles the last year.