Wendy\'s boss wants to use straight-line depreciation for the new expansion proj
ID: 2794032 • Letter: W
Question
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 9%, and its tax rate is 30%.
What would the depreciation expense be each year under each method?
$
How much higher would it be? Round your answer to the nearest dollar.
$
Why might Wendy's boss prefer straight-line depreciation?
Year Scenario 1
(Straight Line) Scenario 2
(MACRS) 1 $ $ 2 $ $ 3 $ $ 4 $
$
How much higher would it be? Round your answer to the nearest dollar.
$
Why might Wendy's boss prefer straight-line depreciation?
Explanation / Answer
Wendy's Boss Year Straight Line Depreciation MACRS Depreciation 1 $600000/4=$150000 $600000*33.33%=$199980 2 $600000/4=$150000 $600000*44.45%=$266700 3 $600000/4=$150000 $600000*14.81%=$88860 4 $600000/4=$150000 $600000*7.41%=$44460 NPV under Straight line Dep Year 0 1 2 3 4 Cash Flow $ 600,000.00 Depreciation $ 150,000.00 $ 150,000.00 $ 150,000.00 $ 150,000.00 EBIT $ (150,000.00) $ (150,000.00) $ (150,000.00) $ (150,000.00) Tax=30% $ (45,000.00) $ (45,000.00) $ (45,000.00) $ (45,000.00) EAT $ (195,000.00) $ (195,000.00) $ (195,000.00) $ (195,000.00) Add: Dep $ 150,000.00 $ 150,000.00 $ 150,000.00 $ 150,000.00 After tax cash flow $ (45,000.00) $ (45,000.00) $ (45,000.00) $ (45,000.00) P.v Factor $ 1.00 $ 0.92 $ 0.84 $ 0.77 $ 0.71 P.V $ 600,000.00 $ (41,265.00) $ (37,890.00) $ (34,740.00) $ (31,860.00) NPV $ 454,245.00 NPV under MACRS Depreciation Year 0 1 2 3 4 Cash Flow $ 600,000.00 Depreciation $ 199,980.00 $ 266,700.00 $ 88,860.00 $ 44,460.00 EBIT $ (199,980.00) $ (266,700.00) $ (88,860.00) $ (44,460.00) Tax=30% $ (59,994.00) $ (80,010.00) $ (26,658.00) $ (13,338.00) EAT $ (259,974.00) $ (346,710.00) $ (115,518.00) $ (57,798.00) Add: Dep $ 199,980.00 $ 266,700.00 $ 88,860.00 $ 44,460.00 After tax cash flow $ (59,994.00) $ (80,010.00) $ (26,658.00) $ (13,338.00) P.v Factor $ 1.00 $ 0.92 $ 0.84 $ 0.77 $ 0.71 P.V $ 600,000.00 $ (55,014.50) $ (67,368.42) $ (20,579.98) $ (9,443.30) NPV $ 447,593.80 NPV is higher in case of using Straight line Depreciation Wendy's Boss prefer straight line depreciation because it would result higher NPV
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