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 $300,000 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 14%, 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. Which depreciation method would produce the higher NPV?
(Straight-line or MACRS)

How much higher would the NPV be under the preferred method? Round your answer to two decimal places.
$ _____

Year Scenario 1
(Straight-Line) Scenario 2
(MACRS) 1 $ _____ $ _____ 2 $ _____ $ _____ 3 $ _____ $ _____ 4 $ _____ $ _____

Explanation / Answer

A.

Depreciation under Straight line method = Cost of equipment / Life of the equipment

= 300000/4 = $75000 per year

B.

Tax saving

Straight line

(Net of tax)

Tax saving

MACRS

(Net of tax)

PVF

@

14%

Discounted

Tax

Saving

(Straight line)

Discounted

Tax

Saving

(MACRS)

MACRS method produces higher NPV

Preferred method is MACRS which produces higher NPV by $5988

Year Straight line MACRS 1 75000 99000 2 75000 135000 3 75000 45000 4 75000 21000

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