Kristin is evaluating a capital budgeting project that should last for 4 years.
ID: 2716058 • Letter: K
Question
Kristin is evaluating a capital budgeting project that should last for 4 years. The project requires $800,000 of equipment. She is unsure what depreciation method to use in her analysis, striaght-line or the 3-year MACRS accelerated method. Under the striaght-line depreciation, the cost of equipment would be depreciated evenly over its 4-year life (ignore the half-year convention for the straight0line method). The applicable MACRS depreciation rates are 33%, 45%, 15% and 7% as discussed in Appendix 12A. The company's 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?
Explanation / Answer
Calculation of Depreciation:
Under Straight Line Method:
Depreciation = Cost - Salvage Value / Life
Depreciation = 800,000 - 0 / 4 = $200,000
a.
b. Calculation of NPV under both the methods:
MACRS method will give higher NPV by $44,738 (932,299 - 887,561)
Straight Line MACRS Year 1 200,000 264,000 Year 2 200,000 360,000 Year 3 200,000 120,000 Year 4 200,000 56,000 Total 800,000 800,000Related Questions
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