Question

Brock Florist Company buys a new delivery truck for $29,000. It is classified as a light-duty truck. Brock is in a 30% tax bracket and has a cost of capital of 8%. Assume that Brock will sell its delivery truck after three years of service for $15,000. a. Calculate the NPV of the equipment purchase using a five-year life with straight-line depreciation to zero salvage. b. Calculate the NPV of the equipment purchase using a five-year life and MACRS depreciation. c. Which of the two depreciation methods would Brock prefer?

Year	3-year Class	5-year Class	7-year Class
1	33.33%	20.00%	14.29%
2	44.45%	32.00%	24.49%
3	14.81%	19.20%	17.49%
4	7.41%	11.52%	12.49%
5		11.52%	8.93%
6		5.76%	8.92%
7			8.93%
8			4.46%

Answer 1

Answer a
Calculation of NPV of the equipment purchase using a five-year life with straight-line depreciation to zero salvage.
Year	0	1	2	3	NPV
Purchase cost of new delivery truck	-$29,000.00
Depreciation tax shield		$1,740.00	$1,740.00	$1,740.00
After tax sale value of delivery truck				$13,980.00
Net Cash flow	-$29,000.00	$1,740.00	$1,740.00	$15,720.00
x Discount factor @ 8%	1	0.925925926	0.85733882	0.793832241
Present Value	-$29,000.00	$1,611.11	$1,491.77	$12,479.04	-$13,418.08
NPV of the equipment purchase using a five-year life with straight-line depreciation to zero salvage =					-$13,418.08
Working
Depreciation per year using straight line method = $29000/5 years = $5800
Depreciation tax shield per year = Depreciation per year x Tax rate = $5800 x 30% = $1740
Calculation of after tax sale value of delivery truck
Sale value	$15,000.00
Less : Book value after 3 years	$11,600.00
Gain on sale	$3,400.00
Tax @ 30% on Gain	$1,020.00
After tax sale value [Sale value - tax]	$13,980.00
Answer b
Calculation of NPV of the equipment purchase using a five-year life and MACRS depreciation
Year	0	1	2	3	NPV
Purchase cost of new delivery truck	-$29,000.00
Depreciation tax shield		$1,740.00	$2,784.00	$1,670.40
After tax sale value of delivery truck				$13,005.60
Net Cash flow	-$29,000.00	$1,740.00	$2,784.00	$14,676.00
x Discount factor @ 8%	1	0.925925926	0.85733882	0.793832241
Present Value	-$29,000.00	$1,611.11	$2,386.83	$11,650.28	-$13,351.78
NPV of the equipment purchase using a five-year life and MACRS depreciation					-$13,351.78
Working
Calculation of depreciation tax shield
Year	Cost of new delivery truck	5 Year Class MACRS rates	Depreciation	Depreciation tax shield @ 30%
1	$29,000.00	20%	$5,800.00	$1,740.00
2	$29,000.00	32%	$9,280.00	$2,784.00
3	$29,000.00	19.20%	$5,568.00	$1,670.40
Calculation of after tax sale value of delivery truck
Sale value	$15,000.00
Less : Book value after 3 years	$8,352.00
Gain on sale	$6,648.00
Tax @ 30% on Gain	$1,994.40
After tax sale value [Sale value - tax]	$13,005.60
Answer c
Brock should prefer MACRS depreciation method as it gives lower net present value of cash flows.