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 $750,000 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 11%, and its tax rate is 35%.

What would the depreciation expense be each year under each method? Round your answers to the nearest cent.

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.
$  

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

Explanation / Answer

Straight-line method:

Annual depreciation = (cost of asset – salvage value)/ life of the asset

                                        = (750,000 -0)/ 4

                                        = 187,500

It will be same for all four years.

MACRS method

Year

Depreciation basis

MACRS rate

Depreciation

1

750000

33%

247500

2

750000

45%

337500

3

750000

15%

112500

4

750000

7%

52500

750000

MACRS method would produce the higher NPV.

Year

Depreciation basis

MACRS rate

Depreciation

1

750000

33%

247500

2

750000

45%

337500

3

750000

15%

112500

4

750000

7%

52500

750000

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