Question

Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires $125,000 of equipment and is eligible for 100% bonus depreciation. She is unsure whether immediately expensing the equipment or using straight-line depreciation is better for the analysis. 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 company's WACC is 10%, and its tax rate is 20%.

a. What would the depreciation expense be each year under each method? Enter your answers as positive values. Round your answers to the nearest dollar.

Year Scenario 1 (Straight-Line) Scenario 2 (Bonus Depreciation)

0 $ $

1 $ $

2 $ $

3   $ $

4 $ $

b. Which depreciation method would produce the higher NPV?

-Select-Straight-Line?

Bonus Depreciation?

please answer on excel and explain please

c. How much higher would the NPV be under the preferred method? Do not round intermediate calculations. Round your answer to the nearest dollar.

$ ----------?

Answer 1

	a	Straight Line Depreciation=125000/4	$31,250
			Year	Scenario 1	Scenario 2
				Straight Line	Bonus Depreciation
			0		$31,250
			1	$31,250	$0
			2	$31,250	$0
			3	$31,250	$0
			4	$31,250	$0
	b	Bonus Depreciation will produce higher NPV
		Because the present Value of Depreciation tax shield will be higher in case of Bonus Depreciation
	c	CALCULATION OF DEPRECIATION TAX SHIELD
		Present ValueTax shield for Bonus Depreciation	$25,000	(125000*20%)
		Present Value of Cash Flow=(Cash Flow)/((1+i)^N)
		i=Discount rate=WACC=10%=0.1, N=Year of cash flow
			N	A	B=A*20%	C=B/(1.1^N)
			Year	Straight Line	Depreciation Tax Shield	Present Value of Tax Shield
			0	$0	$0	$0
			1	$31,250	$6,250	$5,681.82
			2	$31,250	$6,250	$5,165.29
			3	$31,250	$6,250	$4,695.72
			4	$31,250	$6,250	$4,268.83
					SUM	$19,812
		Present ValueTax shield for Straight Line Depreciation	$19,812
		NPV as per Bonus Depreciation will be higher by	$5,188	(25000-19812)