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 $1,600,000 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 9%, and its tax rate is 25%.

What would the depreciation expense be each year under each method? Enter your answers as positive values. Do not round intermediate calculations. Round your answers to the nearest dollar. Year Scenario 1 (Straight Line) Scenario 2 (MACRS) 1 $ $ 2 $ $ 3 $ $ 4 $ $

Which depreciation method would produce the higher NPV, and how much higher would it be? Do not round intermediate calculations. Round your answer to the nearest cent.

Answer 1

Answer : Calculation of Depreciation expense each year under :

Straight Line

Depreciation Expense = Cost of Machine / Useful Life

= 1,600,000 / 4

= 400,000

MACRS

Below is the table showing Calculation of Depreciation under MACRS

Year	Depreciation Rate	Depreciation Expense (1,600,000 * Depreciation rate)
1	33.33%	533280
2	44.45%	711200
3	14.81%	236960
4	7.41%	118560

(ii) To determine which method will producehigher NPV

Year	1	2	3	4
Depreciation under SLM (1)	400000	400000	400000	400000
Depreciation under MACRS (2)	533280	711200	236960	118560
Difference (2) - (1)	133280	311200	(163040)	(281440)
Tax shield on Depreciation @25%	33320	77800	(40760)	(70360)

Below is the table showing Present Value :

Year	Tax shield on Depreciation	PVF @9%	Present Value
1	33320	0.917431193	30568.80734
2	77800	0.841679993	65482.70348
3	-40760	0.77218348	-31474.19865
4	-70360	0.708425211	-49844.79785
		Total	14732.51432

MACRS would produce the higher NPV by 14732.51