Depreciation Methods Wendy\'s boss wants to use straight-line depreciation for t
ID: 2743969 • Letter: D
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 $600,000 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 10%, and its tax rate is 30%.
What would the depreciation expense be each year under each method?
Which depreciation method would produce the higher NPV?
-Select-Scenario 1Scenario 2Item 9
How much higher would it be? Round your answer to the nearest dollar.
$
Year Scenario 1
(Straight Line) Scenario 2
(MACRS) 1 $ $ 2 $ $ 3 $ $ 4 $ $
Explanation / Answer
Part A
Straight line method:
In this method the amount of depreciation expense will be same for all four years.
Depreciation expense = (cost of asset – salvage value)/ life of the project
= (600,000 -0)/4
= 15,000
MACRS method
In this method, amount of depreciation will be cost of asset times macrs rate for the year.
year
Cost
Macrs rate
Depreciation
1
600000
33.33%
199980
2
600000
44.45%
266700
3
600000
14.81%
88860
4
600000
7.41%
44460
Part B
Here we need to compute total present value of depreciation under both the methods. To compute PV, we need to multiply each depreciation amount with respective PV factor.
Year
CF A
CF B
PV factor 10%
PV A
PV B
1
150000
199980
0.90909
136363.6
181800
2
150000
266700
0.82645
123966.9
220413.2
3
150000
88860
0.75131
112697.2
66761.83
4
150000
44460
0.68301
102452
30366.78
Total PV
475479.82
499341.83
Hence, NPV would be higher under MACRS depreciation method.
Difference =499,341.83-475,479.82
= 23862.02
year
Cost
Macrs rate
Depreciation
1
600000
33.33%
199980
2
600000
44.45%
266700
3
600000
14.81%
88860
4
600000
7.41%
44460
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.