Question

6. Problem 12.06 (Depreciation Methods) eBook Kristin is evaluating a capital budgeting project that should last for 4 years. The project requires $950,000 of equipment. She is unsure what depreciation method to use in her analysis, 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%, 45%, 15%, and 7%. The company's WACC is 12%, and its tax rate is 30%. a. What would the depreciation expense be each year under each method? Round your answers to the nearest cent. Year Scenario 1 (Straight-Line) Scenario 2 (MACRS) 2 $ b. Which depreciation method would produce the higher NPV? -Select- How much higher would the NPV be under the preferred method? Round your answer to the nearest cent.

Answer 1

SLM Method: Scenario:1 Year Depreciation % 25% 25% 25% 25% WIN Depreciation Tax saving on depreciation $ 237,500.00 $ 71,250.00 $ 237,500.00 $ 71,250.00 $ 237,500.00 $ $ 237,500.00 $ 71,250.00 PVF@ 12% 0.8929 0.7972 0.7118 0.6355 Present value $ 63,616.07 $ 56,800.06 $ 50,714.34 $ 45,280.66 PV of tax saving $ 216,411.14 MACRS Method: Scenario:2 Year Depreciation % Depreciation Tax saving on depreciation 33.00% $ 313,500.00 $ 94,050.00 45.00% $ 427,500.00 $ 128,250.00 15.00% $ 142,500.00 $ 42,750.00 7.00% $ 66,500.00 $ 19,950.00 WN PVF@ 12% 0.8929 0.7972 0.7118 0.6355 Present value $ 83,973.21 $ 102,240.11 $ 30,428.61 $ 12,678.59 PV of tax saving $ 229,320.52 MACRS will have higher NPV as it has higher PV of tax savings, so scenario 2. Would be higher by $ 12,909.38 [ 229320.52-216411.14]