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Depreciation Methods

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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, straight-line or the 3-year MACRS accelerated method. Under that straight-line depreciation, the cost of the equipment would be depreciated over its 4-year life (ignore the half year convention for stright line method). The applicable MACRS depreciation rates are 33,45,15 and 7 percent. The company's WACC is 10% and its tax rate is40%.

a)What would be 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?

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a. What would the depreciation expense be each year under each method?

Under the straight line method
Depreciation expense = 800,000/4=200,000 per year
Under the MACRS depreciation, the depreciation ...

Solution Summary

The solution explains the calculation of depreciation expense under different methods and the impact on NPV of the project.

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See Also This Related BrainMass Solution

Studying the Effect of the Depreciation Method on NPV

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$1,700,000 of equipment. The company could 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 MARCS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%. 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?

That is the question I am working on. What I am having trouble with is part b.

- Why might Wend's boss prefer straight line depreciation?

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