Problem 11-5 Depreciation Methods Wendy\'s boss wants to use straight-line depre
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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?
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
Depreciation using straight line method
Scenario 1
Year Depreciation
1 $225,000
2 $225,000
3 $225,000
4 $225,000
Total depreciation under straight line method is $ 900,000
Calculation of Depreciation under MACRS method :
Scenerios 2
Year Depreciation % Depreciation value
1 33.33% $299,970
2 44.45% $400,050
3 14.81% $133,290
4 7.41% $66,690
Scenerios 1 : calculation of NPV under straight line method :
NPV = 225,000 / (1+0.09)^1 + 225,000/(1+0.09)^2 + 225,000 (1+0.09)^3 + 225,000/(1+0.09)^4
NPV = 206,422.02 + 189,377.10+ 173,745.17 + 159,393.60
NPV = 728,937.89
Scenerios 2 : NPV using MACRS method
NPV = 299,970/(1+0.09)^1 + 400,050/(1+0.09)^2 +133,290/(1+0.09)^3+66,690/(1+0.09)^4
NPV = 275,201.84 + 336,714.08+102,926.64 + 47244.26
NPV = $762,086.82
NPV is more under the method MACRS as compared to Straight line method even though initially in first two years it was giving higher saving in straight line method.
Saving is $ 33,150 higher in MACRS method.