Question

Kristin is evaluating a capital budgeting project that should last for 4 years. The project requires $900,000 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 9%, 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) 1 पी 2 $ पी 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 % Depreciation Tax saving on depreciation 25% $225,000.00 $ 25% $225,000.00 25% $ 225,000.00 $ 25% $ 225,000.00 $ PVF@9% Present value $ 72,247.71 1 78,750.00 0.9174 $66,282.30 2. 78,750.00 0.8417 $ 60,809.45 0.7722 78,750.00 $55,788.49 78,750.00 0.7084 PV of tax saving $ 255,127.94 MACRS Method: Scenario:2 Year Depreciation % Depreciation 33.00% $ 297,000.00 $ 45.00% $ 405,000.00 $ 15.00% $ 135,000.00 $ 63,000.00 $ Tax saving on depreciation PVF@9% Present value $95,366.97 $119,308.14 1 103,950.00 0.9174 2 141,750.00 0.8417 $36,485.67 3 47,250.00 0.7722 7.00% $ $15,620.78 4 22,050.00 0.7084 PV of tax saving $ 266,781.56 MACRS will have higher NPV as it has higher PV of tax savings. Would be higher by $ 11,653.62 [266781.56-255127.94]