This exercise uses the assumed DHL’s data from SE7-4.
Assume that at the beginning of 2013, DHL, a FedEx competitor, purchased a used Jumbo 747 aircraft at a cost of $52,400,000. DHL expects the plane to remain useful for five years (7.3 million miles) and to have a residual value of $6,400,000. DHL expects to fly the plane 835,000 miles the first year, 1,650,000 miles each year during the second, third, and fourth years, and 1,515,000 miles the last year.
Assume DHL 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.
1. Which depreciation method offers the tax advantage for the first year? Describe the nature of the tax advantage.
2. How much income tax will DHL 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 income tax rate is 36%. Ignore any earnings from investing the extra cash.