chapter 12 4. Depreciation methods Kristin is evaluating a capital budgeting pro
ID: 2644240 • Letter: C
Question
chapter 12
4. Depreciation methods
Kristin is evaluating a capital budgeting project that should last for 4 years. The project requires $400,000 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 13%, and its tax rate is 40%.
a. What would the depreciation expense be each year under each method? Round your answers to the nearest cent.
b. How much higher would the NPV be under the preferred method? Round your answer to two decimal places.
= $
(Straight-Line) Scenario 2
(MACRS) 1 =$ =$ 2 =$ =$ 3 =$ =$ 4 =$ =$
Explanation / Answer
Answer (A) Depreciation under Straight Line method and MACRS method
Year Straight line method Macrs
1 $100000 $400000 *33% = 133333.33
2 $100000 $400000* 45%= 180000
3 $100000 $400000 *15% = 60000
4 $100000 $400000* 7% = 28000
(B) NPV
Since Depreciation saves tax and it will be like cash inflows per year. In case of SLM depreciation will save 10000*40% = $40000 tax per year and in case of Macrs it will be in Year 1 = 133333.33*40%= $53333.33 , Year 2 = $180000 *40% = $72000 , Year 3 = 60000*40% = $24000 , Year 4 = 28000 *40% = $11200.
Below is the NPV under both the method assuming cash outflows are 0 under both the method so that we would be able to compare both the NPV in effective manner
HERE COPY AND PASTE FROM WORD IS NOT WORKING FROM WORD SO I AM DIRECTLY WRITING THE ANSWER
NPV under SLM - $118978.85
NPV under MACRS - $127086.57
So Macrs have $8108.72 ($127086.57- $118978.85) higher NPV than SLM.
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