Question

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 applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%. The project cost of capital is 8%, and its tax rate is 40%.

1. 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	$	$

2. 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.

   The NPV under -Select: (Scenario 1, Scenario) will be higher by $   .

Answer 1

SLM					8%
Year	Cost	Dep rate	Depreciation	Tax saving @ 40%	PV factor	PV
1	1,680,000	25%	420,000	168,000.00	0.925926	155,555.56
2	1,680,000	25%	420,000	168,000.00	0.857339	144,032.92
3	1,680,000	25%	420,000	168,000.00	0.793832	133,363.82
4	1,680,000	25%	420,000	168,000.00	0.73503	123,485.02
					Total PV	556,437.31
MACARS					8%
Year	Cost	Dep rate	Depreciation	Tax saving @ 40%	PV factor	PV
1	1,680,000	33.33%	559,944	223,977.60	0.925926	207,386.67
2	1,680,000	44.45%	746,760	298,704.00	0.857339	256,090.53
3	1,680,000	14.81%	248,808	99,523.20	0.793832	79,004.72
4	1,680,000	7.41%	124,488	49,795.20	0.73503	36,600.96
					Total PV	579,082.89
As we can see the PV of tax saving on MACARS is higher