You Select an Insurance Policy for Your Company That Agrees

Essay

You select an insurance policy for your company that agrees to pay you the depreciated value of a piece of equipment if it is destroyed in an accident, but you have to choose one of two depreciation schedules when you begin the policy. One depreciation schedule is linear and depreciates the value to zero over 10 years. The other depreciation schedule is exponential and depreciates the value at a constant rate of 20% per year. An accident destroys the equipment after 5 years of ownership. Calculate the insurance company's obligation for each plan if the piece of equipment was valued initially at $100,000. Which depreciation schedule would have paid the most? (The cost of the policy is the same, no matter which depreciation schedule you choose.)