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