1. Suppose Congress decided to void the Modified Accelerated Cost Recovery Syste
ID: 2734957 • Letter: 1
Question
1. Suppose Congress decided to void the Modified Accelerated Cost Recovery System (MACRS) and replace it with the Straight Line Depreciation Method. What would be the effect on the calculations for NPV, IRR, MIRR and Payback for: The centrel cheese project itself and capital budgeting analysis within U.S. Economy.
The background to these question is: .
After several months, they felt Central should go ahead with the project. They would set up production in an unused section of their main plant. New machinery with an estimated cost of $2,100,000 would be purchased. Shipping would cost $150,000 and there would be an additional charge of the same amount for installation. Inventories would increase by $75,000 and receivables would increase by $125,000. The machinery was estimated to have a useful life of four years. Depreciation would be on the Modified Accelerated Cost Recovery System (MACRS) with allowances of 33%, 45%, 15% and 7% for the four years of its useful life. The machinery is expected to be sold after four years for $150,000.
The company had been thinking about leasing the unused portion of the factory that is scheduled to be used for the new project. They had received several interesting offers, the most favorable of which was for $20,000 per year.
Annual sales of the new product were estimated to be 150,000 cases at $35 per case. Costs, excluding depreciation, would be 80% of sales. It was felt that existing sales would be cannibalized by $20,000 per year.
Explanation / Answer
CALCULATION OF CASH FLOWS UNDER MACRS
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YEARS 1 2 3 4
1. Sales (150,000 x $35) 5,250,000 5,250,000 5,250,000 5,250,000
2.Costs 4,200,000 4,200,000 4,200,000 4,200,000
3. Depreciation (MACRS) 840,000 1,080,000 360,000 168,000
4. OPPORTUNITY COST 20,000 20,000 20,000 20,000
6. INCOME BEFORE TAX 190,000 (-)50,000 670,000 862,000
7. CASH FLOWS (6+3) 1,030,000 1,030,000 1,030,000 1,030,000
1. COST OF NEW MACHINE FOR DEPRECIAITON PURPOSE : (2,100,000 + 150,000 + 150,000 ) = $2,400,000
MACRS DEPRECIAITON : 1ST YEAR @ 35% $840,000
2ND YEAR @ 45% 1,080,000
3RD YEAR @ 15% 360,000
4TH YEAR @ 7% 168,000/
2. ANNUAL DEPRECIATION UNDER STRAIGHT LINE METHOD
= 2,400,000 COST - 150,000 SALVAGE VALUE /4 = 2250,000/4=562,500
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