Question

DEPRECIATION METHODS

Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires $625,000 of equipment. She is unsure what depreciation method to use in her analysis, 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%, 45%, 15%, and 7%. The company's WACC is 14%, and its tax rate is 30%.

1. What would the depreciation expense be each year under each method? Round your answers to the nearest cent.
   

   Year	Scenario 1 (Straight-Line)	Scenario 2 (MACRS)
   1	$	$
   2
   3
   4

2. Which depreciation method would produce the higher NPV?
   -Select-Straight-LineMACRSItem 9
   
   How much higher would the NPV be under the preferred method? Round your answer to two decimal places. Do not round your intermediate calculations.
   $

Answer 1

Depreciation under SLM
Annual depreciation = 625000/4 = 156250
Year	Depreciation
1	156250
2	156250
3	156250
4	156250
Deprecition under MACRS
Year		Depreciation
1	625000*33%	206250
2	625000*45%	281250
3	625000*15%	93750
4	625000*7%	43750
MACRs method will provide higher NPV
Yer	MACRS Dep	SLM Dep	Difference	Tax shield @30%		PVF at 14%	Present Value
1	206250	156250	50000	15000		0.877193	13157.89
2	281250	156250	125000	37500		0.769468	28855.03
3	93750	156250	-62500	-18750		0.674972	-12655.7
4	43750	156250	-112500	-33750		0.59208	-19982.7
					Excess NPV		9375
NPV will be higher by $ 9375 under MACRs