A company wants to buy 20 tractor trailers. The cost

A company wants to buy 20 tractor trailers. The cost of each tractor trailer is $150,000. These assets are expected to have a useful life of 7 years (1,000,000-mile life) and a salvage value of 20% of the original cost. It is estimated that in the first year, each truck would be driven 100,000 miles and 150,000 miles in year 2. Although the useful life is 7 years, the company is expected to trade-in these tractors for new ones at the end of 5 years. Prior to depreciation and taxes, the company’s income is 1,500,000 and it is in the 21% corporate tax rate. The average assets of the company are $15,000,000 and the average equity is $1,000,000.

1. What depreciation method would you recommend the company select (straight line, activity- based, or accelerated depreciation)?
2. Calculate the depreciation expense for the first two years using straight-line, activity- based, sum-of-the years, and double declining.

3. How would the choice of each method impact the profitability and cash flow of the company?

4.Compute the return on assets and return on equity under each method for Year 1.

5. Will the choice of depreciation method impact the company's cash flow to have the funds to

purchase new fixed assets when the current ones are disposed of?

6. Knowing that the company will have to prepare a tax return as a corporation using accrual accounting, what depreciation method will be used for tax purpose?

7. Knowing the answer to #6 above, would this impact the recommendation you will make for them to use?


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