Audio Transcript Of Asset Replacement

What we’re going to do now is look at the way taxes will alter some of your decision making process. In particular we are going to get at the point that in a business context it often makes more sense to replace a perfect well functioning asset in situations where you wouldn’t do it as a private person. So what we’re going to look at here is the purchase of an automobile. And what we’ve done is we’ve said we’re going to buy this \$10,000 automobile this is what the cost basis is and what we have here in this column that says ‘Car’ these items right here [B2-B7] is what the cash flow on this replacement automobile would look like from a personal finance point of view. So the idea is you have this perfectly well functioning car what you’re going to do is just replace it with another car that cost \$10,000. I know \$10000 for a functioning car sounds like a stretch but it makes all the math nice and simple.

Now the first thing we’re going to do is show you that once you jump into a business context there are some other expenses you need to worry about. The reason why there aren’t any other expenses here is it’s assumed that this car that you’re buying has the other same cost characteristic as the other ones and so we are just looking at the change which is the purchase. The next column over (C1-C7) shows the amount of depreciation you have in each year you that own the vehicle. Now it’s assumed that you’re going to keep the vehicle for the entire time. Because it’s an automobile you know it’s a five year asset. This column right here (F1-F7) is that modified accelerated cost recovery (MACRS) table that you’ve seen a couple of times before. In order to get the depreciation each year all your doing is you take a look at the formula here (C2) is taking the cost basis which is \$10,000 down here (B10) and multiplying it by that fraction of the cost basis you take this depreciation each year is given in the table. So that first year you get you get \$2000 worth of depreciation (C2), the second year you get \$3200 depreciation(C3), the third year you get \$1920 (C4) and so on down the line. The key thing to remember if you’re using the MACRS tables is that it’s just cost basis times the number in that tables. And if you add all these guys up you are fully depreciating the asset, those all add up to the original \$10000. Now again depreciating you know happens when you’re in a business context and because you have depreciation what you have are additional expenses. Even though it is this weird expense that isn’t represented check that is sent to anyone else it still represents an expense which reduces your taxable income. So the idea is that you can take that depreciation expense and say ah-ha! this is how much my taxable income will fall by.