Question

Markov Manufacturing recently spent $13.5 million to purchase some equipment used in the manufacture of disk drives. The firm expects that this equipment will have a useful life of five years, and its marginal corporate tax rate is 21%. The company plans to use straight-line depreciation. a. What is the annual depreciation expense associated with this equipment? b. What is the annual depreciation tax shield? c. Rather than straight-line depreciation, suppose Markov will use the MACRS depreciation method for the five-year life of the property. Calculate the depreciation tax shield each year for this equipment under this accelerated depreciation schedule. d. If Markov has a choice between straight-line and MACRS depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which schedule should it choose? Why? e. How might your answer to part (d) change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years? f. Under the TCJA of 2017, Markov has the option to take 100% "Bonus" depreciation in the year in which the equipment is put into use. This means that in that year, Markov would take the full depreciation expense equivalent to the cost of buying the equipment. Rather than straight-line depreciation, suppose Markov will use the bonus depreciation method. Calculate the depreciation tax shield each year for this equipment with bonus depreciation. g. If Markov has a choice between straight-line, MACRS and bonus depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which schedule should it choose? Why? h. How might your answer to part (g) change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years? Note: Assume that the equipment is put into use in year 1. a. What is the annual depreciation expense associated with this equipment? The annual depreciation expense is $ million. (Round to three decimal places.)

Answer 1

You have asked a question with 8 sub parts. I have addressed the first four sub parts. Please post the balance sub parts as a separate question.

(a) Annual depreciation = Cost / useful life = 13.5 / 5 = $  2.700 million

(b) Annual depreciation tax shield = annual depreciation x tax rate = 2.7 x 21% = $  0.567 million

(c) Please see the table below:

Cost	C	13.5
Year	Depreciation rate	Depreciation ($ mn)	Depreciation Tax shield ($ mn)
	d	D = d x C	D x 21%
1	20.00%	2.700	0.567
2	32.00%	4.320	0.907
3	19.20%	2.592	0.544
4	11.52%	1.555	0.327
5	11.52%	1.555	0.327

(d) 5 years MACRS depreciation schedule enables higher depreciation in the earlier years resulting into higher depreciation tax shield in earlier years. If tax rate is constant, higher tax shield will result into relatively higher NPV for the machine. Hence, Markov should choose 5 years MACRS depreciation schedule.