Ten years ago, Davis Corporation purchased some equipment for $200,000. The company is depreciating the equipment on a straight-line basis and is now about to replace it. The income tax rate has been 40%. The president is shocked to find out that the company does not have enough cash available to replace the equipment because the purchase price has doubled. The president lends the company enough money to buy the new equipment but says, “Now we will record twice as much depreciation as before so that we don’t have this problem again.”

Required: (1) Considering only the preceding facts, by how much do you think the cash balance of the company will have changed over the life of the equipment?

(2) Can the company implement the president’s proposed depreciation policy?

Do you agree that it would be more desirable?

 lop1