Question

4. Problem 12.06 Click here to read the eBook: Analysis of an Expansion Project DEPRECIATION METHODS Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires 5525,000 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 339, 45%, 15%, and 7%. The company's WACC is 10%, and its tax rate is 35%. 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) 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 two decimal places. Do not round your intermediate calculations.

Answer 1

SLM Method: Tax saving on depreciation PVIF @ 10% Present value 45,937.50 0.909 $ 41,761.36 Year Depreciation % Depreciation expense 25% $ 131,250 $ 25% $ 131,250 $ 131,250 $ 25% $ 131,250 $ 45,937.50 0.826 $ 37,964.88 N 25% $ 45,937.50 0.751 $ 34,513.52 w 45,937.50 0.683 $ 31,375.93 PV of Depreciation tax shield $ 145,615.69 MACRS Method: Tax saving on depreciation Present value 55,125.00 33% $ 60,637.50 Year Depreciation % Depreciation expense 173,250 $ 2 45% $ 236,250 $ 15% $ 78,750 $ 7% $ 36,750 $ 82,687.50 PVIF @ 10% 0.909 $ 0.826 0.751 $ 0.683 $ 68,336.78 27,562.50 20,708.11 12,862.50 8,785.26 PV of Depreciation tax shield $ 152,955.15 MACRS will have higher NPV as it has higher PV of tax savings. NPV under preferred method will be higher by $ 7,339.46

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