CFA CFA Level 2 MACRS depreciation: how does it work?

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MACRS depreciation: how does it work?

  • This topic has 3 replies, 2 voices, and was last updated Apr-21 by Zee Tan.
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      Hello!

      I just want to check my knowledge of MACRS depreciation is ok. Do I understand it right that if you have a 3yr project the terminal cashflow in yr 3 will still be using the MACRS % for yr 3 – I’m guessing the 4th extra and last year depreciation amount is shown on financial statements after the project is over and that’s fine and not needed for a TNOCF calculation if the project is only 3yrs?

      Also, for the same example – if you are asked to calculate the first yr after tax cashflow for a 3yr project with MACRS depreciation, you use the yr 1 depreciation MACRS % and put this full % amount in your cashflow calculation even though MACRS assumes half year convention for this full year? I just wanted to double check that you don’t have to divide by 2… so for yr 1 cashflow you would report: 33.33% (3yr MACRS yr 1 amount) multiplied by FCinv outlay amount = pre-tax depreciation amount for yr 1 and NOT 33.33%/2 x FCinv outlay

       

      Thanks!

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      Answering the second part of your question first: If you’re asked to calculate depreciation at the end of the first year with modified accelerated cost recovery system (MACRS) depreciation and the half-year convention, there is a formula to be followed:

      Depreciation in 1st year=Cost×1Depreciation Period×A×Depreciation Convention Depreciation in Later Years=(Residual Value)×1Depreciation Period×A

      A and Depreciation Periods are standard assumed values:

      A is 100% or 150% or 200%

      Useful Life = 3, 5, 7, 10, 15, 20, 25 … depending on asset class

      So depreciation in first year, assuming 200% declining balance method, using half-year convention:

      =cost×13×200%×12=33%

      In other words, if you’re looking up from a table (or given a value) that says this assumes a half-year convention, the given value should already incorporate the half year calculation, i.e. the number is already divided by 2, so don’t divide it by 2 again.

      The first part of your question, I’m not sure if there’s enough info included.

      Assuming your example assumes a double-declining balance method (A = 200%) and half-year convention, there’s depreciation in year 4 (the remaining half year) so book value is not zero if your project ends at end of year 3.

      Terminal Net Operating Cash Flow (TNOCF) = Salvage Value + Net Working Capital Inv – Tax (Salvage Value – End Book Value)

      So TNOCF is calculable at the end of year 3, I’m not following why TNOCF ‘would not be needed’ if the project is only 3 years.

      Thoughts?

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      umm my main thought is where is this formula in the L2 CFA institute books or prep provider materials??!?! Am I going mad? Thanks though does make sense

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        Not sure if CFA curriculum goes into that level of detail. If MACRS is asked in the exam you’ll be provided with tables for the right values etc.

        But sometimes without the whole concept it can ironically be more confusing!

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