Question

endy'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 $700,000 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 50%. What would the depreciation expense be each year under each method? Year Scenario 1 (Straight Line) Scenario 2 (MACRS) 1 $ $ 2 3 4 Which depreciation method would produce the higher NPV? How much higher would it be? Round your answer to the nearest dollar.

Answer 1

STRAIGHT LINE DEPRECIATION:
Year	Depreciation expense	Tax shield on depreciation	PVIF at 8%	PV at 8%
1	$       1,75,000	$                87,500	0.92593	$       81,019
2	$       1,75,000	$                87,500	0.85734	$       75,017
3	$       1,75,000	$                87,500	0.79383	$       69,460
4	$       1,75,000	$                87,500	0.73503	$       64,315
				$    2,89,811
MACRS DEPRECIATION:
Year	Depreciation expense	Tax shield on depreciation	PVIF at 8%	PV at 8%
1	$       2,33,310	$            1,16,655	0.92593	$    1,08,014
2	$       3,11,150	$            1,55,575	0.85734	$    1,33,380
3	$       1,03,670	$                51,835	0.79383	$       41,148
4	$          51,870	$                25,935	0.73503	$       19,063
				$    3,01,606
As the PV of the depreciation tax shield is more under the MACRS
method, it will produce higher NPV.
The NPV would be higher by 301606-289811 =			$          11,795