1. Problem Recognition
The faster/earlier the return of investment (cost recovery), the more interesting the project is (Depreciation Acceleration).
In order to choose and invest on Project XYZ, a PSC company shall conduct economic evaluations prior requesting for Financial Investment Decision. One of which how project are considered economic might be seen by assessing the ability to return capital expenditure from cost recovery using appropriate depreciation method.
2. Feasible Alternatives
Referring to 2017 IRS Depreciation publication this blog post will use 200% declining balance, straight line and a couple other methods
- Double Declining Balance (DDB)
- Sum of The Year Digits (SYD)
- Straight Line (SL)
- Units of Production (UOP)
Company will choose which depreciation methods that will gives best project economic (indicate by High NPV of Cost of Capital return).
In PSC, Depreciation of Capital Expenditure use assumption 0 MMUS$ at year six and Capex Depreciation is part of cost recovery method for cost of capital (Asset) that will be given to Contractor. PSC depreciation will be calculated started from the beginning year in which the assets is Placed into Service (PIS) with a full year depreciation allowed the initial year.
Assuming capital investment for project XYZ is $2,000m with MARR 8.6% (per week 9 blog) using 4 depreciation methods results as follows:
4. Selection of criteria
Selection of preferable alternatives would be based on depreciation method that produces high NPV (fastest recovery of capital expenditure)
5. Analysis & comparison
Based on the comparison above Sum of Year Digit have highest NPV compared to others. In this case there’s no need to pick method that provide earlier cash flow spread due to PSC contract still not due in the near future.
6. Selection of preferred alternative
Sum of Year Digit (SYD) result in highest NPV compared to other depreciation models.
7. Performance monitoring
The Depreciation calculation above can be used when proposing new project to reflect project economic which can be used for project portfolio where higher NPV of capex return means that the project is more economic using SYD and could get faster recovery.
- Internal Revenue Service (IRS). Which Depreciation Method Applies. Retrieved from: https://www.irs.gov/pub/irs-pdf/p946.pdf
- Unit of Production Depreciation
- Units of Production Depreciation
- Wagner, Ralph. Scheduling Best Practice pp 2 – 4. Retrieved from
- Sullivan, William G., Wicks, Elin M. & Koelling, C. Patrick. Engineering Economy, 6th Global Edition.
- Determine Appropriate Depreciation Method on PSC of PT ABC