- 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 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 straight-line method). The applicable MACRS depreciation rates are 33.33%,44.45%,14.81% and 7.41% as discussed in Appendix 11A. The project cost of capital is 10%, and its tax rate is 25%.
- What would the depreciation expense be each year under each method?
- Which depreciation method would produce the higher NPV, and how much higher would it be?
- Why might Wendy’s boss prefer straight-line depreciation?
- The Campbell Company is considering adding a robotic paint sprayer to its production line. The sprayer’s base price is $920,000, and it would cost another $20,000 to install it. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $500,000. The MACRS rates for the first three years are .3333,.4445, and .1481. The machine would require an increase in net working capital (inventory) of $15,500. The sprayer would not change revenues, but it is expected to save the firm $304,000 per year in before-tax operating costs mainly labor. Campbell’s marginal tax rate is 25%.
- What is the Year -0 cash flow?
- What are the cash flows in Years 1, 2, and 3?
- What is the additional Year-3 cash flow (i.e, the after-tax salvage and the return of working capital)?
- If the project’s cost of capital is 12%, what is the NPV?
- St Johns River Shipyard’s welding machine is 15 years, fully depreciated, and had no salvage value. However, even though it is old, it sis still functional as originally designed and can be used for quite a while longer. A new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $27,000 to $74,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 25%, and the project cost of capital is 12%. What is the NPV if the firm replaces the old welder with the new one?
