Question

Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it will give higher net income in earlier years and give him a larger bonus. The project will last 4 years and requires $600,000 of equipment. The company could use either straight-line or the 3-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly over its 4-year life. (Ignore the half-year convention for the straight-line method.) The applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%. The project cost of capital is 8%, and its tax rate is 40%. What would the depreciation expense be each year under each method? Which depreciation method would produce the higher NPV? How much higher would it be? Round your answer to the nearest dollar.

Answer 1

	1	2	3	4	total
staright line method [600000/4]	150000	150000	150000	150000
MACRS	600000*.3333=199980	600000*.4445=266700	600000*.1481=88860	600000*.0741=44460
Difference	49980	116700	(61140)	(105540)
tax sheild /savings	49980*.40=19992	116700*.40=46680	(61140*.40)= (24456)	(105540*.40)=(42216)
PVF 8%	.92593	.85734	.79383	.73503
PRESENT VALUE OF TAX SAVINGS [tax savings *PVF]	18511.19	40020.63	(19413.91)	(31030.03)	8087.89

b)SInce the depreciation under MACRS is higher during initial years which result in higher tax shield during initial period resulting in higher NPV (due to higher present value)

c) NPV will be higher by 8087.88 [ROUNDED TO 8088]