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 $550,000 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 10%, and its tax rate is 30%.

What would the depreciation expense be each year under each method? Round your answers to the nearest cent. Year Scenario 1 (Straight-Line) Scenario 2 (MACRS)

1 $ $

2 $ $

3 $ $

4 $ $

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

Answer:

Thus, from the above calculations we conclude that MACR' s depreciation method will produce the higher NPV. It will produce $ 137,347 - $ 130,757 = $ 6,591 higher NPV than Straight Line method of depreciation.

Particulars Year 1 Year 2 Year 3 Year 4 Total Discount Factor @ 10% 0.9090 0.8264 0.7513 0.6830 Straight Line Depreciation ($ 550,000 / 4) $ 137,500 $ 137,500 $ 137,500 $ 137,500 Tax Saving@30% $ 41,250 $ 41,250 $ 41,250 $ 41,250 PV of Tax Saving $ 37,500 $ 34,091 $ 30,992 $ 28,174 $ 130,757 MACR's Depreciation $ 181,500 $ 247,500 $ 82,500 $ 38,500 Tax Saving@30% $ 54,450 $ 74,250 $ 24,750 $ 11,550 PV of Tax Saving $ 49,500 $ 61,364 $ 18,595 $ 7,889 $ 137,347

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