Gounod Corporation is contemplating the purchase of a new $756,000 machine with a useful life of seven years. Gounod will use the machine for six years, after which time it expects to sell the machine for $30,000.
Gounod expects that the machine will be able to save $260,000 per year in operating costs over its six-year useful life. However, Gounod is not certain about the income tax rates that will be in effect during the six-year useful life of this machine and, consequently, is not sure which depreciation method it should use for the machine. In calculating annual depreciation, Gounod will use a salvage value of zero and a full year’s depre- ciation in both the first and last years. Gounod’s MARR is 15%.
a. Assuming that marginal combined (state and federal) income tax rates remain at 30% for the entire holding period, determine the net present value this opportunity for both straight-line depreciation and sum-of-the-years’ digits depreciation. Which is the better choice?
b. Assuming that marginal combined (state and federal) income tax rates remain at 30% for the first three years and then increase to 40% for the final three years of the holding period, determine the net present value this opportunity for both straight-line depreciation and sum-of-the-years’ digits depre- ciation. Which is the better choice?
c. Assuming that marginal combined (state and federal) income tax rates begin remain at 30% for the first three years and then decrease to 25% for the final three years of the holding period, determine the net present value this opportunity for both straight-line depreciation and sum-of-the-years’ digits depreciation. Which is the better choice?