MODULE 11 Part K

Project Management and Economy-

Engineering economic decision making –
Depreciation

Expected Outcomes
After completing this module, you should be able to describe: the interest and its
equivalent related to engineering cost
 Depreciation
• Asset value depreciates against time. A vehicle valued at $100k
today probably worth at half priced 10 years from now. The
same could be said for any machinery, assembly or software
used.
• The asset probably declines comparable to market value or
against its owner.
• There are several techniques utilize to determine the
depreciation of asset against time;

2
 Depreciation - The straight line calculation

• This technique is known as annual depreciation charge and

suitable mostly on intangible asset / properties that lacks
physical substance and subjective to evaluate. The example
includes copyright, software, patents, goodwill or trademarks.
The straight line calculation is given as;
𝐵−𝑆
• 𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 𝑑𝑡 =
𝑁
• ∴ 𝐵 = 𝑎𝑠𝑠𝑒𝑡 𝑐𝑜𝑠𝑡 $ , 𝑆 = 𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒 $ 𝑎𝑛𝑑 𝑁 =
𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝑙𝑖𝑓𝑒 (𝑦𝑒𝑎𝑟)
3
Example 1
• Compute asset depreciation worth $950 which in 5 years’ time
can be salvage for $72.
Solution
𝐵−𝑆 950−72
• 𝑑𝑡 = = = 175.6
𝑁 5
Year Per annum depreciation 𝑑𝑡 =
𝐵−𝑆 Sum of 𝑑𝑡 Book value of year end
𝑁
($)
1 175.6 175.6 950 - 175.6 = 774.4
2 175.6 351.2 950 – 351.2 = 598.8
3 175.6 526.8 950 – 526.8 = 423.2
4 175.6 702.4 950 – 526.8 = 247.6
5 175.6 878 950 – 878 = 72 4
Example 2
• Compute an annual depreciation of Computer Aided Engineering (CAE)
software worth $150k which in 10 years’ time which can be salvage for
$12k.
Solution
𝐵−𝑆 150𝑘−12𝑘
• 𝑑𝑡 = = = 13.8
𝑁 10
Year Per annum depreciation 𝑑𝑡 =
𝐵−𝑆 Sum of 𝑑𝑡 Book value of year end ($)
𝑁

1 13.8 13.8 150k – 13.8k = 136.2k

2 13.8 27.6 150k – 27.6k = 122.4k
… … … …
… … … …
10 13.8 138 150k – 138k = 12k
5
Depreciation - Sum of Years – Digits depreciation
technique (SOYD)
• It is an arithmetic gradient depreciation. As a result, a longer than straight line depreciation is change
during early years of asset acquisition. Then smaller changes affected the depreciation as an asset
approaching it depreciated life. The depreciation can be calculated as formula 5.3;
• 𝑆𝑢𝑚 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 − 𝑑𝑖𝑔𝑖𝑡𝑠 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑓𝑜𝑟 𝑎𝑛𝑦 𝑦𝑒𝑎𝑟𝑠, 𝑑𝑡 =
𝑅𝑒𝑚𝑎𝑖𝑛𝑖𝑛𝑔 𝑜𝑓 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝑙𝑖𝑓𝑒 𝑎𝑡 𝑡ℎ𝑒 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑜𝑓 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
(𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑒𝑑)
𝑆𝑢𝑚 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠−𝑑𝑖𝑔𝑖𝑡𝑠 𝑓𝑜𝑟 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝑙𝑖𝑓𝑒
𝑁−𝑡+1
• 𝑑𝑡 = 𝐵−𝑆
𝑆𝑂𝑌𝐷
𝑁 𝑁+1
• ∴ 𝑆𝑂𝑌𝐷 = , 𝑡 = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟𝑠, 𝑁 = 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑦𝑒𝑎𝑟𝑠, 𝐵 = 𝑎𝑠𝑠𝑒𝑡 𝑐𝑜𝑠𝑡 ($), 𝑆 =
2
𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒 ($)

6
Example 3
Compute asset depreciation worth $950 which in 5 years’ time can be salvage for $72.
Solution
𝑁 𝑁+1 5 5+1
• 𝑆𝑂𝑌𝐷 = = 𝑆𝑂𝑌𝐷 = = 15
2 2
𝑁−𝑡+1 5−1+1
• 𝑑𝑡=1 = 𝐵 − 𝑆 = 950 − 72 = 292.67 𝑤ℎ𝑖𝑐ℎ 𝑐𝑎𝑛 𝑏𝑒 𝑠𝑢𝑚𝑚𝑎𝑟𝑖𝑧𝑒𝑑 𝑖𝑛 𝑡ℎ𝑒 𝑓𝑜𝑙𝑙𝑜𝑤𝑖𝑛𝑔 𝑡𝑎𝑏𝑙𝑒
𝑆𝑂𝑌𝐷 15

Years, t Depreciation for year t, Sum of depreciation up to Book value at the end of
dt year t, σ𝑡𝑗=1 𝑑𝑗 year t, 𝐵𝑉𝑡 = 𝐵 − σ𝑡𝑗=1 𝑑𝑗 From SOYD calculation it
shows the depreciation rate
1 292.67 292.67 950 – 292.67 = 657.33 decrease as asset
2 234.13 526.80 950 – 526.80 = 423.20 approaching it depreciated
life.
3 175.6 702.40 950 – 702.40 = 247.60
4 117.07 819.47 950 – 819.47 = 130.53
5 58.53 878 950 – 878 = 72

7
Example 4
Compute vehicle depreciation worth $75k which in 9 years’ time can be salvage for $25k.
Solution
𝑁 𝑁+1 9 9+1
• 𝑆𝑂𝑌𝐷 = = 𝑆𝑂𝑌𝐷 = = 45
2 2
𝑁−𝑡+1 9−1+1
• 𝑑𝑡=1 = 𝐵 − 𝑆 = 75 − 25 = 10 𝑤ℎ𝑖𝑐ℎ 𝑐𝑎𝑛 𝑏𝑒 𝑠𝑢𝑚𝑚𝑎𝑟𝑖𝑧𝑒𝑑 𝑖𝑛 𝑡ℎ𝑒 𝑓𝑜𝑙𝑙𝑜𝑤𝑖𝑛𝑔 𝑡𝑎𝑏𝑙𝑒
𝑆𝑂𝑌𝐷 45

Years, t Depreciation for year Sum of depreciation up to Book value at the end of
t, dt year t, σ𝑡𝑗=1 𝑑𝑗 year t, 𝐵𝑉𝑡 = 𝐵 − σ𝑡𝑗=1 𝑑𝑗
1 10 10 75 – 10 = 65
2 8.88 18.88 75 – 18.88 = 56.12
3 7.77 26.65 75 – 26.65 = 48.35
4 6.66 33.31 75 – 33.31 = 41.69
5 5.55 38.86 75 – 38.86 = 36.14
6 4.44 43.3 75 – 43.30 = 31.70
7 3.33 46.63 75 – 46.63 = 28.37
8 2.22 48.85 75 – 48.85 = 26.15
8
9 1.11 49.96 75 – 49.96 = 25.04
Depreciation - Declining Balance Depreciation
(DBB)
• This technique utilizes a constant depreciation rate to the
property’s declining book value. The formula is given as;
2 2
• 𝐷𝐵𝐵 = 𝑑𝑡 = 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒𝑡−1 = (𝑎𝑠𝑠𝑒𝑡 𝑐𝑜𝑠𝑡, 𝐵 −
𝑁 𝑁

9
Example 5
• Compute asset depreciation worth $950 which in 5 years’ time can be salvage for $72.
• Solution
2
• 𝐷𝐵𝐵 = 𝑑1 = 950 = 380 𝑎𝑛𝑑
5
2
• 𝐷𝐵𝐵 = 𝑑2 = 950 − 380 = 228 𝑤ℎ𝑖𝑐ℎ 𝑐𝑎𝑛 𝑏𝑒 𝑠𝑢𝑚𝑚𝑎𝑟𝑖𝑧𝑒𝑑 𝑖𝑛 𝑡ℎ𝑒 𝑓𝑜𝑙𝑙𝑜𝑤𝑖𝑛𝑔 𝑡𝑎𝑏𝑙𝑒
5

Years, t Depreciation for Sum of depreciation up Book value at the end

year t, dt to year t, σ𝑡𝑗=1 𝑑𝑗 of year t, 𝐵𝑉𝑡 = 𝐵 −
σ𝑡𝑗=1 𝑑𝑗
1 380 380 950 – 380 = 570
2 228 608 950 – 608 = 342
3 136.80 744.80 950 – 744.80 = 205.20
4 82.08 826.88 950 – 826.88 = 123.12
5 49.25 876.13 950 – 876.13 = 73.87 10
 Conclusion
• Three different approach of depreciation technique was
discussed. Each can be used at different situation depending
on to maximize the approximation value.

11
• A small enterprise company is planning on the acquisition of a
used 3-ton lorry ($4500) for department of shipping and
receiving. It is expected by owning the vehicle a saving of
$1500 per year is capable to be achieve in 5 years. Then the
vehicle can be salvage around $1000.
• What is the before-tax rate of return?
• What is the after-tax rate of return of this expenditure? Use a
straight line depreciation.

12
13
14
15
16