Declining Balance Method

• In this method, sometimes called the constant percentage method or the

Matheson Formula, it is assumed that the annual cost of depreciation is a fixed
percentage of the salvage value at the beginning of the year. The ratio of the
depreciation in any year to the book value at the beginning of that year is
constant throughout the life of the property and is designated by , the rate of
depreciation.
• = depreciation during the nth year
Year Book value at Depreciation Book value at the end of year
beginning of year during the year
1
2
3
∙∙∙ ∙∙∙ ∙∙∙ ∙∙∙
n
∙∙∙ ∙∙∙ ∙∙∙ ∙∙∙
L
• This method does not apply, if the salvage value is zero, because will
be equal to one and will be equal to .
Problem 1

• A certain type of machine loses 10% of its value each year. The
machine costs 2,000.00php originally. Makes out a schedule showing
the yearly depreciation, the total depreciation and the book value at
the end of each year for 5 years.
Solution:
Year Book value at Depreciation Book value at the end of year
beginning of year during the year
1
2
3
n
L

Year Book value at Depreciation during Total depreciation Book value at the
beginning of year the year 10% at end of year end of year
1 P 2,000.00 P 200.00 P 200.00 P 1,800.00
2 1,800.00 180.00 380.00 1,620.00
3 1,620.00 162.00 542.00 1,458.00
4 1,458.00 145.80 687.80 1,312.00
5 1,312.20 131.22 819.02 1,180.98
Problem 2

• A certain photocopy machine costs 200,000php with a trade-in value

of 20,000php after making 400,000 copies. Using DBM, what is the
book value when the machine had made 300,000 copies?
Solution:

• =200,00 =20,000

= 5.756

=
= P35,570.35
Problem 3

• A machine initially worth 70,000php depreciates in value each year by

14% of its value at the beginning of that year. Find its book value
when it is 7 years old.
Solution:

• =70,000
Double Declining Balance (DDB) Method

• This method is very similar to the declining balance method except

that the rate of depression is replaced by

When the DDB method is used, the salvage value should not be
subtracted from the first cost when calculating the depreciation charge.
Problem 1

• Determine the rate of depreciation, the total depreciation up to the

end of the 10th year and the book value at the end of 10 years for an
asset that costs P20,000.00 new and has an estimated scrap value of
P4,000.00 at the end of 20 years by (a) the declining balance method
and (b) the double declining balance method.
Solution:
• =P20,000 =P4,000 =20

• (a) Declining balance method

• = 0.0773 or 7.73%
• = = 20,000 = P8,946
• = P11,054

• (b) Double declining balance method

• Rate of depreciation = = = 0.20 or 20%
• = 20,000= P6,974
• 20,000 6,974 = P13,026
Problem 2

• A man bought a tractor for P400,00 and used it for 12 years, the life
span of the equipment. What is the book value of the tractor after 6
years of use? Assume a scrap value of P24,000 for straight line
method; P20,000 for textbook declining balance method and P18,000
for the double declining balance method.
Solution:
• =400,000 =6

• (a) Straight line method

• = P188,000

• (b) Declining balance method

• 400,000 P89,443

• (c) Double declining balance method 18,000

• P133,959
Problem 3

• A baker bought an oven for P30,000 and used it for 6 years, the life
span of the equipment. What is the book value of the oven after 3
years of use? Assume a scrap value of P15,000 for straight line
method; P12,000 for textbook declining balance method and P9,000
for the double declining balance method.
Solution:
• =30,000 =3

• (a) Straight line method

• = P7,500

• (b) Declining balance method

• 30,000 P18,974

• (c) Double declining balance method 9,000

• P8,889
The Rate of Return (ROR) Method

• The rate of return on the capital invested is given by the formula;

Rate of Return =

Net Annual Profit = Annual revenue – Annual cost

ROR
• It is measure of the effectiveness of an investment of capital. It is
financial efficiency. When this method is used, it is necessary to
decide whether the computed rate of return is sufficient to justify the
investment. The advantage of this method is that it is easily
understood by management and investors. The application of the rate
of return method is controlled by the following conditions. A single
investment of capital at the beginning of the first year of the project
life and identical revenue and cost date for each year. The capital
invested is the total amount of capital invested required to finance
the project, whether equity or borrowed.
Annual Worth Method
• In this method, interest on the original investment (sometimes called
minimum required profit) is included as a cost. If the excess of annual
cash inflows over annual cash outflows is not less than zero the
proposed investment is justified – is valid. This method is covered by
the same limitations as the rate of return pattern a single initial
investment of capital and uniform revenue and cost throughout the
life of the investment.
The Present Worth (PW) Method
• This pattern for economy studies is based on the concept of present
worth. If the present worth of the net cash flows is equal to, or
greater than zero, the project is justified economically.
• The present worth method is flexible and can be used for any type of
economy study. It is used extensively in making economy studies in
the public works field, where long-lived structures are involved.
The Future Worth (FW) Method
• The future worth method for economy studies is exactly comparable
to the present worth method except that all cash inflows and
outflows are compounded forward to a reference point in time called
the future.
• If the future worth of the net cash flows is equal to, or greater than
zero, the project is justified economically.
The Payback (Payout) Period Method
• The payback period is commonly defined as the length of time
required to recover the first cost of an investment from the net cash
flow produced by that investment for an interest rate of zero.

• Payout period (years) =

Problem 1

• A machine is invested at php 450,000.00 which will have a salvage

value of 15% of its original cost. The machine could generate an
income at 150,000 within its useful life of 10 years. Maintenance cost
of the machine is estimated to 25,000.00 per year. Considering taxes
and insurance at 8% of the first cost per year. What is the annual
profit using ROR method? The company assumes at least 20% capital
earnings before the income taxes.
Solution:
By the rate of return method

• Annual revenue : 150,000.00 php

Annual cost:
depreciation:
operation and maintenance: 25,000.00 php
taxes and insurance: 450,000(0.08) = 36,000
total annual cost: 75,734.95 php
net annual profit: 74,265.05 php
Rate of return: x 100 = 16.50%
*Since the rate of return is less than 25%, the investment is not justified.
By the annual worth method
• Annual revenue : 150,000.00 php
Annual cost:
depreciation:
operation and maintenance: 25,000.00 php
taxes and insurance: 450,000(0.08) = 36,000
interest on capital: 450,000(0.20) = 90,000
total annual cost: 165,734.95php
excess: -15,734.95php
*Since the excess of annual cash inflows over annual cash outflows is less than zero
(-15,734.95), the investment is not justified.
By the present worth method
• PW of cash inflows = 150,000 (
= 150,000 (
= 639,776.25php
Annual costs (excluding depreciation) = 25,000 + 450,000 (0.08)
= 61,000
PW of cash outflows = 450,000 + 61,000 () = 705,740.80php
PW of the net cash flows = 639,776.25 – 705,740.80 = -65,964.55

*Since the PW of the net cash flows is less than zero (-65,964.55), the investment is
not yet justified.
By the future worth method
• Referring to the cash flow solution by the PW method.

FW of cash inflows = 67,500 + 150,000 ()

= 67,500 + 150,000 (25.9587)
= 3,961,305
FW of cash outflows = 61,000 () + 450,000
= 61,000 (25.9587) + 450,000 (6.1917)
= 4,369,745.7
FW of the net cash flow = 3,961,305 - 4,369,745.7 = -408,440.7

*Since the FW of the net cash flows is less than zero (-408,440.7), the investment is not
justified.
By the payback method

• Total annual cost = 25,000 + 450, 000 (0.08) = 61,000

• Net annual cash flows = 150,000 – 61,000 = 89,000

• Payback period =
= 4.3 years
Problem 2
An investment of P350,00 can be made in a project that will produce a
uniform annual revenue of 195,000 for 6 years and then have a salvage
value of 15% of the investment. Out-of-pocket costs for operation and
maintenance will be P70,000 per year. The company expects capital to
earn 30% before the income taxes. Is this desirable investment? What is
the net annual profit? with taxes and insurance of 6% of the
investment.
Solution:
• Co P350,000
• CL 15%(350,00)=P52500
• Annual Revenue P195,000
Annual Cost:
Depreciation: (d)(SFM)= = P23,322.30
Operation and maintenance: = P70,000
Taxes and insurance: 6%(P350,000) = P21,100
Total annual cost: = P114,422.3
• Net Annual profit = Annual Revenue-Annual Cost
P195,000 - P114,422.3 = P80,577.7
• ROR= x 100% = x100% = 23.02%

• Since 23.0% 30%; not desirable/ not justified

By the annual worth method
• Annual Revenue P195,000
• Annual Cost:
• Depreciation: (d)(SFM)= = P23,322.30
• Operation and maintenance = P70,000
• Taxes and insurance: 6%(P350,000) = P21,100
• Interest on Capital: (.30) (P350,000) = P105000
•
• Total Annual Cost = P219,422.3
• AW = P195,000-P219422.3 = (-24,422.3)

• Since AW is (-24,422.3) :, the investment is not justified

By the present worth method
• PW of cash inflows = 195,000 (
= 195,000 (
= P526,205
Annual costs (excluding depreciation) = 70,000 + 195,000 (0.06)
= 81,700
PW of cash outflows = 195,000 + 81,700 () = P410,912
PW of the net cash flows = 526,205 – 410,912 = -115,293

*Since the PW of the net cash flows is less than zero (-115,293), the
investment is not yet justified.
By the future worth method
• Referring to the cash flow solution by the PW method.

FW of cash inflows = 52,500 + 195,000 ()

= 52,500 + 195,000 (2.6427)
= 567,827
FW of cash outflows = 81,700 () + 350,000
= 81,700 (2.6427) + 350,000 (4.8268)
= 1,905,289
FW of the net cash flow = 567,827 - 1,905,289 = -1,337,462

*Since the FW of the net cash flows is less than zero (-1,337,462), the investment is
not justified.
By the payback method

• Total annual cost = 70,000 + 195,000 (0.06) = 81,700

• Net annual cash flows = 195,000 – 81,700 = 113,300
• Payback period =
= 2.6 years
Problem 3

• An air conditioner is invested at 100,000.00php which will have a

salvage value of 10% of its original cost. The air conditioner could
generate an income at 50,000 within its useful life of 10 years.
Maintenance cost of the machine is estimated to 20,000.00 per year.
Considering taxes and insurance at 5% of the first cost per year. What
is the annual profit? The company assumes at least 20% capital
earnings before the income taxes.
Solution:
by the rate of return method

• Annual revenue : 50,000.00 php

Annual cost:
depreciation:
operation and maintenance: 20,000.00 php
taxes and insurance: 100,000(0.05) = 5,000php
total annual cost: 28,467php
net annual profit: 21,533php
Rate of return: x 100 = 21.53%

*Since the rate of return is less than 25%, the investment is not justified.
By the annual worth method

• Annual revenue : 50,000.00 php

Annual cost:
depreciation: 3,467
operation and maintenance: 20,000.00php
taxes and insurance: 100,000(0.05) = 5,000php
interest on capital: 100,000(0.20) = 20,000
total annual cost: 48,467php
excess: -1,533php
*Since the excess of annual cash inflows over annual cash outflows is less
than zero (-1,533), the investment is not justified.
By the present worth method
• PW of cash inflows = 50,000 (
= 50,000 (
= 211,240php
Annual costs (excluding depreciation) = 20,000 + 100,000 (0.05)
= 25,000
PW of cash outflows = 25,000 + 100,000 () = 444,247php
PW of the net cash flows = 211,240 – 444,247 = -233,007

*Since the PW of the net cash flows is less than zero (-233,007), the
investment is not yet justified.
By future worth method
• Referring to the cash flow solution by the PW method.

FW of cash inflows = 10,000 + 50,000 ()

= 10,000 + 50,000 (25.9587)
= 1,307,935
FW of cash outflows = 25,000 () + 100,000
= 25,000 (25.9587) + 100,000 (6.1917)
= 1,268,138
FW of the net cash flow = 1,268,138 – 1,307,935 = -39,797

*Since the FW of the net cash flows is less than zero (-39,797), the investment is not
justified.
By the payback method

• Total annual cost = 20,000 + 100, 000 (0.05) = 25,000

• Net annual cash flows = 50,000 – 25,000 = 25,000

• Payback period =
= 3.6 years
GROUP MEMBERS
• CALLUENG, DESIREE M.
• DINNAYAN, KRYSTAN A.
• DINULONG, HAPPILYN A.
• GALLEMA, KRIS TEA I.
• MASSAGAN, JOLINA A.

(BSCE – 2A)