UNIT 4

PRESENT VALUE METHOD

Present value method

The present value method for evaluating alternatives is very popular because the
expenses or future income are transformed into equivalent dollars of now. That is, all the
future cash flows associated with an alternative are converted into present dollars. In this
It is very easy, even for a person who is not familiar with economic analysis, to see the
economic advantage of one alternative over another.

The comparison of alternatives with equal lives using the present value method is
direct. If both alternatives with identical capacities are used for the same period of time,
These are called service alternatives as well.

Often, the cash flows of an alternative represent only outflows, it is

to say, no entries are estimated. For example, one might be interested in identifying the process whose
initial, operational, and maintenance costs equivalent are lower. At other times, the flows
cash will include receipts and disbursements. Receipts, for example, could come from the
sales of a product, the salvage values of equipment or realizable savings associated with
a particular aspect of the alternative. Given that most of the problems that will be considered
involve both inputs and disbursements, the latter being represented as negative flows of
cash and the entries as positives.

Therefore, although the alternatives only involve disbursements, or inflows and

disbursements, the following guidelines apply to select an alternative using the measure of
present value value:

An alternative: If VP >= 0, the required rate of return is achieved or exceeded and th

the alternative is financially viable.

Two or more alternatives: When only one alternative can be chosen (the alternatives are
mutually exclusive), the one with the higher present value should be selected.
numerical terms, that is, less negative or more positive, indicating a lower cost VP or
VP higher than a net cash flow of inflows and outflows.

From now on, the symbol VP will be used instead of P to indicate the amount of present value of
an alternative.

Example: Make a comparison of the present value of the service machines for which
The costs are shown below, if i = 10% per year.

Type A Type B
Initial cost (P) $ 2500 3500
Annual Operating Cost (AOC) $ 900 700
$ 200 350
Life (years) 5 5

The solution is as follows:

-$5787.54
-$5936.25

A traveling agent expects to buy a used car this year and has estimated the following
information: The initial cost is $10,000; the commercial value will be $500 in 4 years; the
annual maintenance and insurance costs are $1,500; and the additional annual income due to the
The travel capacity is $5,000. Will the travel agent be able to obtain an annual return rate of 20%?
about your purchase?
Solution: Calculate the PV of the investment with i = 20%
VP = -10000 + 500(P/F,20%,4) - 1500(P/A,20%,4) + 5000(P/A,20%,4) = -$698.40
You will not get a return rate of 20% because NPV is less than zero.

Present value comparison of alternatives with different lifespans

When the present value method is used to compare mutually exclusive alternatives.
exclusive ones that have different lives, a similar procedure to the previous one is followed, but with a
Exception: The alternatives must be compared over the same number of years. This is necessary.
Well, a comparison involves calculating the present equivalent value of all cash flows.
cash futures for each alternative. A fair comparison can only be made when the
Present values represent the costs and the entries associated with an equal service.

The inability to compare an equal service will always favor the shorter life alternative.
(for costs), even if it were not the cheapest, since there are fewer cost periods
involved. The service requirement can be met through two approaches:

Compare the alternatives over a period of time equal to the least common multiple.
(MCM) of their lives.

Compare the alternatives using a study period of length 'n' years, which does not
necessarily considers the lives of the alternatives. This is called the horizon approach
planning.

For the MCM approach, equal service is achieved by comparing the least common multiple of the
lives between the alternatives, which automatically causes their cash flows to extend to
same period of time. That is to say, it is supposed that the cash flow for a 'cycle' of a
the alternative must be multiplied by the least common multiple of the years in terms of money value
constant. Then, the service is compared over the same total lifespan for each alternative. For
For example, if you want to compare alternatives that have lifespans of 3 and 2 years, respectively, the
alternatives are evaluated over a period of 6 years. It is important to remember that when one
alternative has a positive or negative terminal salvage value, this must also be included and
to appear as an income in the cash flow diagram of each life cycle. It is obvious that a
A procedure like this requires making some assumptions about the alternatives in its
subsequent life cycles. Specifically, these assumptions are:

The alternatives under consideration will be required for the least common multiple of years or
more.

The respective costs of the alternatives in all subsequent life cycles will be
the same as in the second.

The second assumption is valid when cash flows are expected to change with the rate of
inflation or deflation exactly, which is applicable throughout the time period LCM. If it
wait for the cash flows to change at some other rate, then a study must be conducted on the
period based on the VP analysis. This statement also holds true when it cannot be done.
the assumption during the time when alternatives are needed.

For the second approach of the study period, a time horizon is selected on the
which should carry out the economic analysis and only those cash flows that occur during that
time periods are considered relevant for the analysis. The other cash flows that
happen beyond the stipulated horizon, whether they come in or go out, are ignored. It must
to establish and use a realistic estimated salvage value at the end of the study period of both
alternatives. The selected time horizon could be relatively short, especially when
Short-term business goals are very important, or vice versa. In any case, once
that the horizon has been selected and the cash flows have been estimated for each alternative, it
determine the VP values and choose the most economical one. The concept of study period or
planning horizon is particularly useful in the replacement analysis.
 Example: A plant manager is trying to decide between two excavators.
based on the estimates presented below:

Machine A Machine B
Initial cost P 11000 18000
Annual operating cost 3500 3100
Salvage value 1000 2000
Life (years) 6 9

Determine which one should be selected based on a present value comparison.

using an annual interest rate of 15%.

If a study period of 5 years is specified and the values are not expected to
Saving changes, which option should be selected?

Which machine should be selected over a horizon of 6 years if the value is estimated
The salvage value of machine B is $6000 after 6 years?
Solution:

Since the machines have different lifespans, they must be compared with their LCM,
It is 18 years. For life cycles after the first one, the initial cost is repeated in year 0 of the new one.
cycle, which is the last year of the previous cycle. These are years 6 and 12 for machine A and year 9
for machine B.

VPA = -11000-11000(P/F,15%,6)-11000(P/F,15%,12)-3500(P/A,15%,18)
-$38599.20
-18000 - 18000(P/F,15%,9) - 3100(P/A,15%,18) + 2000(P/F,15%,9) + 2000(P/F,15%,18)
$41384.00

Machine A is selected since it costs less in terms of PV than machine B.

For a 5-year planning horizon, cycle repetitions are not needed and VSA =
$1000 and VSB = $2000 in year 5. The VP analysis is:

VPA = -11000 - 3500(P/A,15%,5) + 1000(P/F,15%,5) =-$22235.50

-18000 - 3100(P/A,15%,5) + 2000(P/F,15%,5) = -$27397.42

Machine A remains the best choice.

For the 6-year planning horizon, VSB = $6000 in year 6.

-$23813.45
-$27138.15

Definitely, machine A is the best alternative.

The company ASVERA Cementos plans to open a new quarry. Two plans have been designed for
the movement of raw material from the quarry to the plant. Plan A requires the purchase of
two dump trucks and the construction of a unloading platform at the plant. Plan B requires the
construction of a conveyor belt system from the quarry to the plant. The costs for
Each plan is detailed further below in the corresponding table.

Through the analysis of the VP, determine which plan should be selected if money matters.
currently 15% per year.

Plan A Plan B
 platform dump truck Conveyor belt
Initial cost 45000 28000 175000
Annual operating cost 6000 300 2500
Salvage value 5000 2000 10000
Life (years) 8 12 24

Solution: The evaluation must include the LCM of 8 and 12, that is, 24 years. The reinvestment in
the 2 dump trucks will occur in years 8 and 16, and the platform must be bought again in the
Year 12. No reinvestment is needed for plan B.

To simplify the calculations, let's analyze that the CAO of plan A is $9800 higher than
for plan B (2 trucks = (12000 + 300) - 2500 = 9800

Therefore, the VPA = VP dump trucks + VP platform + VPCAO

VP dump trucks = -90000 - 90000(0.3269) - 90000(0.1069) + 10000(0.3269) + 10000(0.1069) +
10000(0.0349) =-$124355.00
VP platform = -28000 - 28000(0.1869) + 2000(0.1869) + 2000(0.0349) = -$32789.60
VPCAO = -9800(6.4338) =-$63051.24
Therefore the VP plan A = -$220195.84

For plan B, it is resolved as follows:

VP plan B = -175000 + 10000(0.0349) = -$174651.00

As can be seen, the most viable plan is plan B (it is the least negative), so it
should opt for this alternative and build the conveyor belt.

Example: A restaurant owner is trying to decide between two emptiers.

waste garbage. A common steel emptying machine (AC) has an initial cost of $65000 and a lifespan of
4 years. The other alternative is a rust-resistant emptying device made primarily of steel.
stainless steel (AI), whose initial cost is $110,000; it is expected to last 10 years. Because ...
Vacuum AI has a slightly larger engine, its operation is expected to cost around
$5000 more per year than that of the AC emptying machine. If the interest rate is 16% per year, which alternative should be
select oneself?

AC: P = $65000; n = 4 años; A = $0.00

$110000
VP (AC) = -65000 - 65000(P/F,16%,4) - 65000(P/F,16%,8) - 65000(P/F,16%,12) -
65000(P/F,16%,16) =-$137,722.00
VP (AI) = -110000 - 110000(P/F,16%,10) - 5000(P/A,16%,20) = -$164,581.00

You should acquire the common steel emptier, as it has the lowest total present value.

Capitalized cost calculations

The capitalized cost (CC) refers to the present value of a project whose useful life is assumed to last
forever. Some public works projects such as dams, irrigation systems and
railways are in this category. Additionally, the permanent staff of universities
Charity organizations are evaluated using capitalized cost methods. In general, the
procedure followed when calculating the capitalized cost of an infinite sequence of cash flows
is the following:

Draw a cash flow diagram that shows all costs and/or income not
recurring (once) and at least two cycles of all recurring costs and inputs
(periodicals).
Find the present value of all non-recurring amounts.
 Find the equivalent uniform annual value (VA) over a lifecycle of all the
recurring amounts and add this to all the other uniform amounts that occur in the
years 1 to infinity, which generates a total equivalent annual uniform value (VA).

Divide the VA obtained in step 3 by the interest rate 'i' to obtain the cost.
capitalized.

Add the value obtained in step 2 to the value obtained in step 4.

The purpose of starting the solution by drawing a cash flow diagram should be
evident. However, the cash flow diagram is probably more important in the
capitalized cost calculations that in any other place, because this facilitates the differentiation between
non-recurring amounts and recurring or periodic amounts.

Capitalized cost = PV / i or FV = PV / i; P = A / i

Example: Calculate the capitalized cost of a project that has an initial cost of $150,000 and
an additional investment cost of $50,000 after 10 years. The annual operating cost will be
$5,000 for the first 4 years and $8,000 thereafter. It is also expected that there will be a
considerable recurring adaptation cost of $15,000 every 13 years. Assume that i = 15%
annual.

P1 = -150,000 - 50,000(P/F,15%,10[0.2472]) = -$162,360.00

-$436.65
P2 = -436.65 / 0.15 = -$2911.00
P3 = 5,000 / 0.15 = -$33,333.33
P4 = -3,000 / 0.15 (P/F,15%,4[0.5718]) = -$11,436.00
VP = P1 + P2 + P3 + P4 = -$210,040.33

There are currently two locations under consideration for the construction of a bridge that crosses the
Ohio River. The north side, which connects a major state highway making a circular route.
Interstate around the city would greatly relieve local traffic. Among the disadvantages of
this place mentions that the bridge would do little to alleviate local traffic congestion during the
congestion hours and it would have to be extended from one hill to another to cover the widest part
from the river, the railway lines, and the local highways that are below. Consequently, I would have to
to be a suspension bridge. The south side would require a much shorter space, allowing the
construction of a truss bridge, but it would require the construction of a new road.

The suspension bridge would have an initial cost of $30,000,000 with annual costs of
inspection and maintenance of $15,000. In addition, the concrete floor would need to be repaved.
every 10 years at a cost of $50,000. It is expected that the truss bridge and the roads will cost
$12,000,000 and have annual maintenance costs of $10,000. Likewise, it would have to be
polished every 10 years at a cost of $45,000. It is expected that the cost of acquiring the right of way
they are $800,000 for the suspension bridge and $10,300,000 for the lattice bridge.
Compare the alternatives based on their capitalized cost if the interest rate is 6% per year.

Solution:

Alternativa 1: P = 30,000,000 + 800,000; A = 15,000; R1 = 50,000 c/10 años.

Alternativa 2: P = 12,000,000 + 10,300,000; A = 8,000; R1 = 10,000 c/ 3 años; R2 =45,000 c/ 10
years.

VP1 = -30,000,000 - 800,000 - (15,000/0.06) - ((50,000/0.06)(A/F,6%,10)[0.07587]) = -

$31,113,225.00
-12,000,000 - 10,300,000 - ((10,000/0.06(A/F,6%,3)[0.31411]) - ((45,000/0.06(A/F,6%,10)
-$22,542,587.50
The truss bridge must be built, as its capitalized cost is lower.
 Example: An engineer from a city is considering two alternatives for the supply of
local water. The first alternative consists of constructing an earthen dam over a river
nearby, which has a highly variable flow. The reservoir will create a dam, so that the
city can have a water source on which it can depend. The initial cost is expected to
a reservoir worth $8,000,000 with annual maintenance costs of $25,000 and that the reservoir lasts
indefinitely.

As an alternative, the city can drill wells as needed and build

aqueducts to transport water to the city. The engineer estimates that initially a
average 10 wells at a cost of $45,000 each, including the conveying pipe.
the average lifespan of a well is expected to be 5 years with an annual operating cost of $12,000
by well. If the interest rate used is 15% per year, determine which alternative should
select based on their capitalized costs.

Alternativa 1: P = 8,000,000; A = 25,000

Alternativa 2: P = 45,000 * 10; n = 10 años; A = 12,000 * 10
VP1 = -8,000,000 - 25,000/0.15 = -$8,166,666.67
A1 = -45,000*10(A/P,15%5[0.29832]) = -134,244.00
A2 = 12,000 * 10 = 120,000
VP2 = (A1 + A2)/i = (-134,244 - 120,000) / 0.15 = -$1,694,960.00

Costs are considerably cheaper than the reservoir.

Equivalent Annual Uniform Value Method

The VA method is commonly used to compare alternatives. VA means that all the
income and disbursements are converted into a uniform equivalent annual amount at the end of
period, which is the same every period.

The main advantage of this method over all others lies in the fact that it does not
requires making a comparison about the least common multiple of the years when the alternatives
they have different useful lives, that is, the NPV of the alternative is calculated for a life cycle
only, because as its name implies, the VA is an annual equivalent value over the life of the
project. If the project continues for more than one cycle, it is assumed that the equivalent annual value
during the following cycle and all subsequent cycles is exactly the same as for the first one,
as long as all current cash flows are the same for each cycle.
The repeatable condition of the uniform annual series across various life cycles can
to demonstrate with the following example.

The annual value for two life cycles of an asset with an initial cost of $20,000, a cost of
annual operation of $8,000 a life of 3 years and an i=22%.

The VA for a life cycle will be calculated as follows:

VA = -20,000(A/P,22%,3[0.48966])-8000 = -$17793.20
VA for two life cycles:
VA = -20,000(A/P,22%,6[0.31576])-20,000(P/F,22%,3[0.5507])(A/P,22%,6)-8000 = -$17793.20

Study period for alternatives with different useful lives

The annual value method for comparing alternatives is probably the simplest to
To carry out. The selected alternative has the lowest equivalent cost or the highest equivalent income.
high

Perhaps the most important rule to remember when making VA comparisons is the one that states
that only a life cycle of each alternative should be considered, which is due to the fact that the VA will be the
the same for any number of life cycles as for one.
Example: The following data has been estimated for two tomato peeling machines that
they provide the same service, which will be evaluated by a manager of a canning plant:
 Machine A Machine B
Initial cost 26,000 36,000
Annual maintenance cost 800 300
Annual labor cost 11,000 7,000
Annual ISR - 2,600
Salvage value 2,000 3,000
Life in years 6 10

If the minimum required rate of return is 15% per year, which machine should be selected?
manager?

VAA = -26,000(A/P,15%,6[0.26424]+2000(A/F,15%,6[0.11424]) - 11800

-$18,441.76
VAB = -36000(A/P,15%,10[0.19925])+3000(A/F,15%10[0.04925]) -9900
-$16,925.25

Machine B is selected as it represents the lowest annual cost.

Suppose that the company from the previous example is planning to exit the business of
Canned tomatoes within 4 years. By that time, the company expects to sell machine A.
at $12,000 or machine B at $15,000. It is expected that all other costs will remain the same.
Which machine should the company buy under these conditions?

If all costs, including salvage values, are the same as they had been
Originally estimated, which machine should be selected using a horizon of 4 years?

-$18,503.78
-$19,505.67
The machine A is selected.

VAA = -26000(A/P,15%,4[0.35027]) + 2000(A/F,15%,4[0.20027])-11800 = -$20,506.48

VAB = -36000(A/P,15%,4[0.35027]) + 3000(A/F,15%,4[0.20027]) - 9900 = -$21,908.91
The machine A is selected.

Salvage value amortization method

When an asset has a terminal salvage value (TSV), there are many ways to calculate
the VA.

In the salvage amortization method, the initial cost P is first converted

in a uniform annual equivalent amount using the A/P factor. Given normally, its character
of positive cash flow, after its conversion to a uniform equivalent amount through
From the A/F factor, the salvage value is added to the annual equivalent of the initial cost. These calculations
They can be represented by the general equation:

VA = -P(A/P,i,n) + VS(A/F,i,n); naturally, if the alternative has any other cash flow of
cash, this must be included in the full calculation of VA.

Example: Calculate the VA of a tractor attachment that has an initial cost of $8000 and a
salvage value of $500 after 8 years. It is estimated that the annual operating costs of the
The machine costs $900 and an annual interest rate of 20% is applied.
VA = -8000(AP,20,8[0.26061]) + 500(AF,20,,8[0.06061]) - 900 = -2954.58
 Example: a local pizzeria has just purchased a fleet of five mini electric vehicles to
make deliveries in an urban area. The initial cost was $4600 per vehicle and its expected lifespan and
salvage values are 5 years and $300 respectively. Combined costs are expected to
insurance, maintenance, surcharge, and lubrication are $650 the first year and increase by $50 annually
from then on. The delivery service will generate an estimated additional amount of $1200 annually. If
a return of 10% per year is required, use the PV method to determine if the purchase should have been made
having been made.

VA = 5*4600(AP,10,5[0.2638]) + 5*300(AF,10,5[0.1638]) - 650 - 50(AG,10,5[1.8101]) + 1200 = -

$5362.21
Since VA is less than 0 and a return of 10% is expected, the purchase is not justified.

Salvage Value Present Value Method

The present value method also converts investments and salvage values into a
The present value of salvage is deducted from the initial investment cost and the resulting difference is
annualized with the A/P factor over the asset's life.
The general equation is: VA = -P + VS(P/F,i,n)(A/P,i,n).
The steps to obtain the VA of the complete asset are:

Calculate the present value of the salvage value using the P/F factor.
Combine the value obtained in step 1 with the investment cost P.
Annualize the resulting difference over the asset's life using the A/P factor.
Combine any uniform annual value with step 3.
Convert any other cash flow into an equivalent uniform annual value and combine with the
value obtained in step 4.

Example: Calculate the VA of the tractor attachment from the previously analyzed example using the
present value method of salvage.
-$2,954.57

Equivalent annual uniform cost of a perpetual investment

The evaluation of flood control projects, irrigation channels, bridges, or others

large-scale projects require the comparison of alternatives whose lifespans are so long that
they can be considered infinite in terms of economic analysis. For this type of analysis it is
It is important to recognize that the annual value of the initial investment is simply equal to the annual interest.
gained on global investment, as expressed by the following equation: A = Pi.

The cash flows that are recurring at regular or irregular intervals are managed.
exactly the same as in conventional VA calculations, that is to say, they are converted to amounts
equivalent annual uniforms over a cycle, which automatically annualizes them for each
later life cycle.

The water operator system of the state of Puebla is considering two proposals for
increase the capacity of the main channel in its irrigation system in the valley below.

Proposal A would involve dredging the channel in order to remove the sediment and the
debris accumulated during its operation in previous years. Given that the capacity of the channel
will have to stay close to the flow in the future, due to the higher demand for water, the office
is planning to purchase dredging equipment and accessories for $65,000. The equipment is expected to have
a 10-year life and a salvage value of $7,000. It is estimated that the annual costs of labor
The work and operation for the functioning of the dredging total $22,000. To control the
Weed formation in the canal itself and along the banks will be controlled with herbicides during the
irrigation season. The annual cost of the weed control program is expected to be $12,000.
Proposal B would involve lining the channel with concrete at an initial cost of
$650,000. It is supposed that the coating is permanent, but it will be necessary to carry out some
maintenance each year at a cost of $1,000. In addition, repairs will have to be made to
coating every 5 years at a cost of $10,000. Compare the two alternatives based on value
equivalent annual uniform using an annual interest rate of 5%.

A B
-$65,000 P = -$650,000
n = 10 years -$1,000
$7,000 $10,000 (every 5 years)
-$22,000
-$12,000

VAA = -65000(AP,5,10[0.1295] + 7000(AF,5,10[0.07950]) - 22000 - 12000 = -$41,861.00

VAB = -650,000(0.05) - 1000 - 10,000(AF,5,5[0.18097]) = -$35,309.70

Option B should be selected as it represents the lowest equivalent uniform annual value.
Example: If young Vera deposits at an annual interest rate of 7%, how many years must he
How much money needs to be accumulated before I can withdraw $1,400 annually indefinitely?

VPn = VA/i = 1400/0.07 = 20,000 is the necessary present value.

How long will the initial $10,000 take to become $20,000?
F = P(F/P, 7%, n) ----- 20000 = 10000(1.07)^n
n = ln 2 / ln 1.07
n = 10.24 years.

Depreciation Models
Depreciation terminology

The following defines some commonly used terms in depreciation. The terminology
It applies to corporations just like to individuals who own depreciable assets.

Depreciation: It is the reduction in the value of an asset. Depreciation models use rules,
rates and formulas approved by the government to represent the present value in the books of the
Company.
Initial cost: Also called unadjusted basis, it is the installed cost of the asset that includes the
purchase price, delivery and installation commissions, and other directly depreciable costs in the
which are incurred in order to prepare the asset for use. The term unadjusted basis, or simply
base, and the symbol B are used when the asset is new.
Book value: Represents the remaining, undepreciated investment in the books after the
The total amount of depreciation charges to date has been deducted from the base.
Recovery period: It is the depreciable life, n, of the asset in years for depreciation purposes.
of the ISR). This value may differ from the estimated productive life due to the laws
Government regulations govern the allowable recovery and depreciation periods.
Market value: It is the estimated amount that could be obtained if an asset were sold in the open market.
Due to the structure of the depreciation laws, the book value and the market value can
to be substantially different.
Depreciation rate: Also called recovery rate, it is the fraction of the initial cost that is
eliminates due to depreciation each year. This rate can be the same each year, then called
straight-line rate, or it may be different for each year of the recovery period.
Salvage value: It is the estimated exchange or market value at the end of the useful life of the
salvage value, VS, expressed as an amount in dollars estimated or as a
percentage of the initial cost, it can be positive, zero, or negative due to the costs of
dismantling and exclusion.
Personal property: It consists of the tangible possessions of a corporation, producers.
from income, used for conducting business. It includes most of the industrial property
manufacturer and service: vehicles, manufacturing equipment, handling mechanisms
materials, computers, office furniture, refining process equipment, and much more.
Real estate: Includes the land and improvements to it and similar types of property.
example: office buildings, manufacturing structures, warehouses, apartments. The land itself is
considered as real property, but it is not depreciable.
Half-year convention: It assumes that the assets start to be used or are disposed of.
mid-year, regardless of when such events actually occur during the year.
6.2 Straight-Line Depreciation
The straight-line model is a depreciation method used as the standard of comparison.
for most of the other methods. It gets its name from the fact that the book value is
linearly reduce over time since the depreciation rate is the same each year, it is 1 over
the recovery period. Therefore, d = 1 / n. Annual depreciation is determined
multiplying the initial cost minus the estimated salvage value by the depreciation rate d,
which is equivalent to dividing by the payback period n. In equation form it looks like this
way

Dt = (B - VS) / d = (B - VS) / n
Where: t = year (1, 2, … n)
Dt = annual depreciation charge
B = initial or base cost not adjusted
estimated salvage value
d = depreciation rate (the same for all years)
n = recovery period or expected depreciable life
Given that the asset depreciates by the same amount each year, the book value after t years
of service, VLt, will be equal to the unadjusted base B minus the annual depreciation, multiplied by t.
dt = 1 / n.

Example: If an asset has an initial cost of $50,000 with an estimated salvage value of
calculate the annual depreciation
of each year, using the straight-line depreciation method.
The depreciation for each year can be obtained using the equation:
Dt = (B - VS) / n = (50000 - 10000) / 5 = $8000 each year.
(b) The book value after each year t is calculated using the equation
VLt = V - tDt
VL1 = 50000 - 1*8000 = 42000
VL2 = 50000 - 2*8000 = 34000
VL3 = 50000 - 3*8000 = 26000
VL4 = 50000 - 4*8000 = 18000
50000 - 5*8000 = 10000 = VS

Depreciation by the sum-of-the-years'-digits method

The digit sum method of the years (SDA) is a classic technique of accelerated depreciation that
eliminates a large part of the base during the first third of the recovery period. This technique can
it can be used in economic engineering analyses, especially in the accounts of
depreciation of multiple assets.
The mechanics of the method initially involve finding S, the sum of the digits of the total number of years.
from 1 to the recovery period n. The depreciation charge for any given year is obtained
multiplying the asset base minus any salvage value (B - VS) by the rate of
number of years remaining in the recovery period over the sum of the digits of the total years,
S.
(depreciable years remaining / sum of the digits of total years) (base - value of
(salvage) = (n - t + 1)/S (B - VS)
Where S is the sum of the digits of the total years from 1 to n.
j = (n(n + 1))/2
The book value for a year t is calculated as:
VLt = B - (t(n - t/2 + 0.5)/S) (B - VS)
The depreciation rate dt, which decreases each year for the SDA method, follows the multiplier in the
equation:
dt = n - t + 1 / S

Example: Calculate the SDA depreciation charges for years 1, 2, and 3 of an electronic equipment with
B = $25000, VS = $4000 y un periodo de recuperación de 8 años.
The sum of the digits of the total years is S = 36 and the depreciation amounts for the first 3
years are:
$4666.67
D2 = (8 - 2 + 1 / 36) * (25000 - 4000) = $4083.33
$3500.00

Depreciation using the declining balance method and double declining balance.

The declining balance method, also known as the uniform percentage method or
fixed, it is a model of accelerated cancellation. In simple terms, the annual depreciation charge is
determined by multiplying the book value at the beginning of each year by a uniform percentage, which is
it will be called d, in equivalent decimal form. For example, if the uniform percentage rate is 10%
That is, d = 0.10, the cancellation of depreciation for any given year will be 10% of the value in
books at the beginning of that year. The depreciation charge is higher during the first year and decreases
for every year that happens.

The maximum allowable depreciation percentage is double the straight-line rate. When
this rate is used, the method is known as double declining balance (DDB). Therefore, if an asset
it had a useful life of 10 years, the straight-line recovery rate would be 1/n = 1/10 and the rate
The uniform for SDD would be d = 2/10 or 20% of the book value. dmax = 2 / n
This is the rate used for the SDD method. Another percentage commonly used for the method
SD is 150% of the straight-line rate, where d = 1.50/n.
The real depreciation rate for each year t, relative to the initial cost is:
dt = d(1 - d)t - 1

For SD or SDD depreciation, the estimated salvage value is not deducted from the initial cost.
calculate the annual depreciation charge. It is important to remember this feature of the SD models.
and SDD.

Although salvage values are not considered in the SD model calculations, no

an asset can depreciate below a reasonable salvage value, which can be zero. If the
Book value reaches the estimated salvage value before year n, it cannot be carried out.
no additional depreciation.
The depreciation for year t, Dt, is the uniform rate, d, multiplied by the book value at
end of the previous year. Dt = (d)VLt-1
If the value VLt-1 is not known, the depreciation charge can be calculated as:
Dt = (d)B(1-d)t -1
 The book value in year t can be determined in two ways. First, using the rate
uniform D and the initial cost B.
Likewise, VLt can always be determined for any depreciation model by subtracting
the current depreciation charge of the previous book value, that is:
VLt = VLt -1 - Dt
The book value in declining balance methods never reaches zero. There is a VS involved.
after n years, which is equal to VL in year n.
VS involved = VLn = B(1-d)n
If the involved VS is lower than the estimated VS, the asset will be fully depreciated before the end.
of their expected life.
It is also possible to determine an implied uniform depreciation rate using the amount VS
dear. For VS > 0, d involved = 1 - (VS/B)^(1/n)
Example: Suppose an asset has an initial cost of $25000 and an estimated salvage value.
de $4000 después de 12 años. Calcule su depreciación y su valor en libros para (a) año 1 y (b) año 4.
(c) Calculate the implied salvage value after 12 years for the SDD model.
Solution: First, calculate the SDD depreciation rate, d.
d = 2/n = 2/12 = 0.1667
(a) for the first year, depreciation and book value are calculated using the equations
corresponding:
$4167.5
VL1 = 25000(1 - 0.1667)1 = $20832.50
(b) for year 4, the corresponding equations with d = 0.1667 result in:
D4 = 0.1667(25000)(1 - 0.1667)^4 - 1 = 2411.46
VL4 = 25000(1 - 0.1667)^4 = $12054.40
The implied salvage value after year 12 is:
VS involved = 25000(1 - 0.1667)12 = $2802.57
Since the estimated VS of $4000 is greater than $2802.57, the asset will be fully depreciated.
before reaching its expected life of 12 years. Therefore, once VLt reaches $4000, it does not
they allow additional depreciation charges; in this case, VL10 = $4036.02. Using the equation
D11 = $672.80, so VL11 = $3362.22, which is less than the estimated VS of $4000. Then,
During years 11 and 12, the amounts of depreciation will be D11= $36.02 and D12 = 0.
Example: The company Hylsa acquired a computer-controlled unit for qualifying metals.
for $80000. The unit has an expected life of 10 years and a salvage value of $10000. Use the method of
decreasing balance to develop a depreciation program and the book values for each year.
Solution: Using the corresponding equation, the implied depreciation is determined using the
VS = 10000
d = 1 - (10000/80000)^(1/10) = 0.1877
Year t Dt VLt
0 - 80000
1 15016 64984
2 12197 52787
3 9908 42879
4 8048 34831
5 6538 28293
6 5311 22982
7 4314 18668
8 3504 15164
9 2846 12318
10 2318 10000