Question

In: Finance

Wendy’s boss wants to use straight-line depreciation for the new expansion project because he said it...

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 $1,700,000 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%, as discussed in Appendix 11A. The project cost of capital is 10%, and its tax rate is 25%.

PLEASE SHOW YOUR WORK AND FORMULAS

a.What would the depreciation expense be each year under each method?

b.Which depreciation method would produce the higher NPV, and how much higher would it be?

c.Why might Wendy’s boss prefer straight-line depreciation?

Solutions

Expert Solution

Question a:
Calculation of Depreciation Expense
Year Depreciation Base Depreciation Rates MACRS Depreciation Straight line Depreciation
A B C D = B*C E = B*25%
1 1700000 33.33% 566610 425000
2 1700000 44.45% 755650 425000
3 1700000 14.81% 251770 425000
4 1700000 7.41% 125970 425000
Question b:
Present Value of Depreciaiton Tax shileld
MACRS Method
Year Depreciation Tax Shield Discount Factor @10% Discounted Cash Flows
A B C = B*25% D=1/(1+10%)^A E = C*D
1 566610 141652.5 0.909090909 128775.00
2 755650 188912.5 0.826446281 156126.0331
3 251770 62942.5 0.751314801 47289.63186
4 125970 31492.5 0.683013455 21509.80124
PV 353700.47
Straight Line Method
Year Depreciation Tax Shield Discount Factor @10% Discounted Cash Flows
A B C = B*25% D=1/(1+10%)^A E = C*D
1 425000 106250 0.909090909 96590.91
2 425000 106250 0.826446281 87809.91736
3 425000 106250 0.751314801 79827.1976
4 425000 106250 0.683013455 72570.17963
PV 336798.20
MACRS method provides higher NPV than Straight line Depreciation
Difference in NPV = PV of MACRS Method tax shield - PV of Straight Line Method tax shield
                 = $353,700.47 - $336,798.20
                 = $16,902.26
Thereforem it will increase NPV by $16,902.26
Question c:
Straight line method is easy to calculate and will have less errors

jeff jeffy answered 2 years ago
Next > < Previous

Related Solutions

Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it...
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...
Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it...
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 $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...
Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it...
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 $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...
endy's boss wants to use straight-line depreciation for the new expansion project because he said it...
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...
Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it...
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 $1,770,000 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...
Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it...
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 $1,730,000 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 Methods Wendy's boss wants to use straight-line depreciation for the new expansion project because he...
Depreciation Methods 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 $1,680,000 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...
A project will require the investment of $108,000 in equipment (straight line depreciation with a depreciable...
A project will require the investment of $108,000 in equipment (straight line depreciation with a depreciable life of 10 years and zero salvage value). The annual project income after all expenses except depreciation have been paid is projected to be $24,000. Assume a 34% income tax rate for this corporation. The corporation wants a 15% after-tax rate of return on its investments after 10 years. Determine by present worth analysis whether this project should be undertaken.
Explain how straight- line depreciation is computed.
Explain how straight- line depreciation is computed.
(Straight Line Depreciation) A new machine cost $100,000, and will increase inventory by $10,000, A/R by...
(Straight Line Depreciation) A new machine cost $100,000, and will increase inventory by $10,000, A/R by $15,000, and A/P by $5,000. This machine will reduce our expenses by $18,000 per year. The machine will be depreciated to a zero book value in 10 years, but could be sold for $12,000 at the end of 10 years. The marginal tax rate is 35%, and the cost of capital is 12%. Calculate the payback, NPV, IRR, and PI.
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT