Question

DEPRECIATION METHODS

Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires $400,000 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 13%, and its tax rate is 40%.

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 line or MACRS
   
   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

Answer (a):

Working:

Depreciation under SLM = (Cost of equipment - Salvage value) /Useful life = (400000 - 0) / 4 = $100,000

Answer (b):

(i) MACRS method would produce the higher NPV

(ii) MACRS method NPV would be higher by $7,635.75

Let us calculate the PV of depreciation tax shields provided under both method and calculate the difference: