Question

ABC Corp. is considering investing in a project requiring the purchase of a depreciable asset. The initial cost of the asset is $800,000 with no expected salvage value. There are two methods of depreciating this asset that are acceptable to the IRS. The amount of depreciation expense that would be recognized by year appears below for each of the two methods:

Method	Year 1	Year 2	Year 3	Year 4
1	$200,000	$200,000	$200,000	$200,000
2	$400,000	$400,000	0	0

Assuming a tax rate of 40%, and an interest rate of 18%, which method (1 or 2) should be chosen to maximize the net present value of the asset? Indicate both your choice of method, and how much increase to net present value this method would add over the method you did not select.

Group of answer choices

$88,400: Choose Method 1

$35,360: Choose Method 2

$35,360: Choose Method 1

$88,400: Choose Method 2

Answer 1

				Depreciation * Tax Rate
				Tax Saving-Income			Present Value
	Method 1	Method 2	Tax Rate	Method 1	Method 2	Present Discount Factor @ 18%	Method 1	Method 2
Year 1	200,000	400,000	40%	80,000	160,000	0.8475	67,800	135,600
Year 2	200,000	400,000	40%	80,000	160,000	0.7182	57,456	114,912
Year 3	200,000	-	40%	80,000	-	0.6086	48,688	-
Year 4	200,000	-	40%	80,000	-	0.5158	41,264	-
							215,208	250,512
								35,304
		Since Present Value is higher in Method 2 (This is income as Tax Saving)
		Answer is B
Difference in above value is due to lack of information for Rounding off, I have rounded off at 4 decimal places