Problem 11-5 Depreciation Methods Wendy\'s boss wants to use straight-line depre
ID: 2451734 • Letter: P
Question
Problem 11-5
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 50%.
a. What would the depreciation expense be each year under each method?
b. Which depreciation method would produce the higher NPV?
How much higher would it be? Round to nearest dollar.
Please show your work.
Explanation / Answer
(a). Depreciation under straight line value method
Cost of Equipment = $600,000
Depreciation for each year = $600,000/4
= $150,000
Depreciation under MACRS
(b) Tax savings under straight line method = $150000*50%*3.17
= $2,37,750
Statement showing Tax Saving under MACRS
Tax savings under straight line method is more than tax savings under MACRS therefor straight line method will result in higher NPV.
Year opening WDV Rate Depreciation Closing WDV 1 $600000 33.33% $200,000 $400,000 2 $400,000 44.45% $177800 $222,200 3 $222200 14.81% $32908 $189292 4 $189292 7.41% $14027 $175265