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.
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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.