Depreciation methods Kristin is evaluating a capital budgeting project that shou

Question

Depreciation methods Kristin is evaluating a capital budgeting project that should last for 4 years. The project requires $875,000 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 30%. What would the depreciation expense be each year under each method? Round your answers to the nearest cent Which depreciation method would produce the higher NPV? How much higher would the NPV be under the preferred method? Round your answer to two decimal places.

Explanation / Answer

Year Scenario1 Tax Saving on depr @30% Scenario1 Tax Saving on depr @30%                              1.00               218,750.00                                                 65,625.00                                  288,750.00                                    86,625.00                              2.00               218,750.00                                                 65,625.00                                  393,750.00                                  118,125.00                              3.00               218,750.00                                                 65,625.00                                  131,250.00                                    39,375.00                              4.00               218,750.00                                                 65,625.00                                     61,250.00                                    18,375.00               875,000.00                                              262,500.00                                  875,000.00                                  262,500.00 Year PVF Tax Saving on depr @30% PV of Tax saving on depr Tax Saving on depr @30% PV of Tax saving on depr                              1.00                        0.8850                                                 65,625.00                                     58,075.22                                    86,625.00                                    76,659.29                              2.00                        0.7831                                                 65,625.00                                     51,394.00                                  118,125.00                                    92,509.20                              3.00                        0.6931                                                 65,625.00                                     45,481.42                                    39,375.00                                    27,288.85                              4.00                        0.6133                                                 65,625.00                                     40,249.04                                    18,375.00                                    11,269.73                                              262,500.00                                  195,199.68                                  262,500.00                                 207,727.08 b) MACRS method would produce the higher NPV since PV of tax savings on depreciation is higher in MACRS Method c) NPV under MACRS method would be greater by $12,527.40(207,727.08 - 195,199.68)

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