Question Details

Impact of Depreciation MASON ENGINEERING COMPANY 
Case 9-2 Purchase of Assets
On October 10, 2005, Mason Engineering Company completed negotiations
on a contract for the purchase of new equipment. Under the terms of the
agreement, the equipment may be purchased now or Mason may wait until
January 10, 2006, to make the purchase. The cost of the equipment is
$400,000. It will be financed by a note bearing interest at the market rate of
interest. Straight-line depreciation over a ten-year life will be used for book
purposes. A double-declining balance over seven years will be used for tax
purposes. (One-half year- depreciation will be taken in the year of purchase
regardless of the date of purchase.)
 Required:
a. Discuss the financial statement impacts of postponing the purchase of
the equipment. Would the market price of the firm- common stock be
affected by any or all of these impacts? Do not assume in your discussion
that the postponement will affect revenues or any operating costs,
other than depreciation.
Ans.  Yes the share price of the company gets affected. The company should buy equipment in October 2009, rather than January 2010. If the company purchases equipment in month of October, the company charges 6 month deprecation expenses in 2009, so the company gets tax benefit in 2009. Thus because of this, the earning per share will increase. As result, the market price of share will also boost up.  On the other hand, If the company buys this equipment in 2010, the EPS of 2009 will not get affected and market price of share will also not get affected. 
b. Discuss any cash flow impacts related to postponing the purchase of
the equipment.
Ans. When anybody buys and sells some assets against cash, the cash flow of the company will get affected. The Mason Engineering Company is going to buy machine against interest bearing notes.  Thus the cash flow statement of the company will note get affected whether the company will buy machine in October 2009 or January 2010.  This activity of the company is not related any cash transaction. 
 
c. Efficient markets assume that stockholder wealth is affected by the
amount and timing of cash flows. Which alternative is more favorable
to them: purchasing before year-end or waiting until January? Explain
your answer.              
Ans. As discussed that the purchasing of machine against interest bearing notes is not related to cash transaction, the cash account of the company will not get affected.  Thus it is non cash activity of the firm.  Furthermore, the net wealth of the shareholders is get affected due to earning per share and tax impact on the earnings. If the company purchases machine October, the company will reap benefit of taxation in October. Thus the net wealth of the shareholders will increase in 2009. 



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