Problem 11-5 Depreciation Methods Wendy\'s boss wants to use straight-line depre
ID: 2766239 • 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 $900,000 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 50%.
What would the depreciation expense be each year under each method?
Which depreciation method would produce the higher NPV?
-Select-
Scenario 1
Scenario 2
How much higher would it be? Round your answer to the nearest dollar.
$
Year Scenario 1
(Straight Line) Scenario 2
(MACRS) 1 $ $ 2 $ $ 3 $ $ 4 $ $
Explanation / Answer
Senerio 1 : depreciation using straight line method
Cost of equipment = $ 900,000
Life = 4 years
Depreciation = $ 900,000 / 4 years = 225,000 per annum
Year Depreciation
1 $ 225,000
2 $225,0000
3 $225,000
4 $225,000
Caccusation of NPV =( 225,000/(1+0.09) + 225,000/(1+0.09)^2 + 225,000/(1+0.09)^3+225,000/(1+0.09)^4 ) - 900,000
NPV = $ 206422.01 + $119617.23 + $173745.17 + $159393.60 - $900000 = - $240,821.99
Scenerio 2 : calculation of depreciation using MACRS method
Year calculation depreciation
1 ($ 900,000× 33.33%) $ 299,970
2 ($900,000× 44.45%) $400,050
3 ($900,000×14.81%) $133,290
4 ($900,000×7.41%) $66,690
Total depreciation $ 900,000
Calculation of NPV
NPV = $299970/(1+0.09)^1+ $400050/(1+0.09)^2 +133290/(1+0.09)^3+$66690/(1+0.09)^4 -$900,000
NPV = 275201.84 +212679.43+102926.64 +47244.26 - 900000 = - $ 261,947.83
NPV under straight line method is better it is giving saving of $ 21125.84