Question

DEPRECIATION METHODS Charlene is evaluating a capital budgeting project that should last for 4 years. The project requires $750,000 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 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? MACRS How much higher would the NPV be under the preferred method? Round your answer to two decimal places. Do not round your intermediate calculations. Check My Work (1 remaining)

Answer 1

Year Scenario1 Scenario2
1 =750000/4=187500 =750000*33%=247500
2 =750000/4=187500 =750000*45%=337500
3 =750000/4=187500 =750000*15%=112500
4 =750000/4=187500 =750000*7%=52500

MACRS produces higher NPV

NPV is higher by Present value of difference in depreciation*tax rate=((247500-187500)/1.12+(337500-187500)/1.12^2+(112500-187500)/1.12^3+(52500-187500)/1.12^4)*35%=11890.21786