13-5 Depreciation Methods Wendy%u2019s boss wants to use straight-line depreciat
ID: 2702403 • Letter: 1
Question
13-5 Depreciation Methods
Wendy%u2019s 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 $1,700,000 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 33.3%, 44.45%, 14.81%, and 7.41%, as discussed in Appendix 13A. The company%u2019s WACC is 10%, and its tax rate is 40%.
a. What would the depreciation expense be each year under each method?
b. Which depreciation method would produce the higher NPV, and how much higher would it be?
c. Why might Wendy%u2019s boss prefer straight-line depreciation?
13-5 Depreciation Methods Wendy%u2019s 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 $1,700,000 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 33.3%, 44.45%, 14.81%, and 7.41%, as discussed in Appendix 13A. The company%u2019s WACC is 10%, and its tax rate is 40%. What would the depreciation expense be each year under each method? Which depreciation method would produce the higher NPV, and how much higher would it be? Why might Wendy%u2019s boss prefer straight-line depreciation?Explanation / Answer
a. What would the depreciation expense be each year under each method? Depreciation Under SLM Each year Depreciation = 1,700,000/4 =425,000 Depreciation Under MACRs 1st Year = 1700,000*33.3% = $566,100 2nd Year = 1700,000*44.45% = $755,650 3rd Year = 1700000*14.81% = $251,770 4th Year = 1700000*7.41% = $125970 b. Which depreciation method would produce the higher NPV, and how much higher would it be? Depreciation Under MACRS would produce the higher NPV NPV Higher would be = 566100*0.4/1.10 +755650*0.4/1.1^2 + 251770*0.4/1.1^3 + 125970*0.4/1.1^4 - 425000*40%PVIFA(10%,4) = $565,735.29 %u2013 538877.13 = $26,858.16 c. Why might Wendys boss prefer straight-line depreciation? Wendys boss prefer straight-line depreciation because he thinks that it will give higher net income in earlier year as less depreciation would be charged in earlier year
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.