Depreciation Methods Wendy\'s boss wants to use straight-line depreciation for t

Question

Depreciation Methods

Wendy's boss wants to use straight-line depreciation for the new expansion project because he said it will give higher net income in earlier years and give him a larger bonus. The project will last 4 years and requires $700,000 of equipment. The company could use either 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 33.33%, 44.45%, 14.81%, and 7.41%. The company's WACC is 8%, and its tax rate is 35%.

What would the depreciation expense be each year under each method?

Year

1

2

3

4

Which depreciation method would produce the higher NPV?

How much higher would it be? Round your answer to the nearest dollar.

Scenario 1
(Straight Line)

Scenario 2
(MACRS)

Year

1

2

3

4

Which depreciation method would produce the higher NPV?

How much higher would it be? Round your answer to the nearest dollar.

Scenario 1
(Straight Line)

Scenario 2
(MACRS)

Explanation / Answer

Depriciation per year using straight line method = 700000/4 = 175000

Depriciation per year using Macrs method = 700000 * Depriciation rate

PV using straight line method = 175000*0.35/1.08 + 175000*0.35/1.08^2 + 175000*0.35/1.08^3 + 175000*0.35/1.08^4

= 202867.77

PV using Macrs Method

= 233310*0.35/1.08 + 311150*0.35/1.08^2 + 103670*0.35/1.08^3 + 51870*0.35/1.08^4

=211123.97

since Depriciation expense of Macrs is greater than straight line method

we say that Straight line method produces higher NPV

and it is higher by $8256.20

year Straight Line Marcs 1 175000 233310 2 175000 311150 3 175000 103670 4 175000 51870

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