Intermediate Financial Management (MindTap Course List)
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN: 9781337395083
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
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Chapter 13, Problem 5P

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 the straight-line method.) The applicable MACRS depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%, as discussed in Appendix 13A. The project cost of capital is 10%, and its tax rate is 40%.

  1. a. What would the depreciation expense be each year under each method?
  2. b. Which depreciation method would produce the higher NPV, and how much higher would it be?
  3. c. Why might Wendy’s boss prefer straight-line depreciation?
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Thomson Media is considering some replacing its equipment. The new equipment will reduce the operating costs by $40,000 every year. It requires initial costs of $80,000 and installation fees of $30,000. The new equipment has a 4-year tax life and would be fully depreciated by the straight-line method, but it would have a salvage value of $25,000 at the end of Year 4, when the project would be closed down. Also, some new working capital of $20,000 would be required, but it would be recovered at the end of the project's life. The old equipment has salvage value of $50,000 today and $18,000 in 4 years. Its book value is $36,000 and gets depreciated by $9,000 every year. The tax rate is 30%, and WACC is 9%. What is the project's NPV?
RocketOwl, Inc. is considering a new product to bring to market. They estimate the product would have a viable market for five years. If they wish to do the project they will need to purchase equipment with a price of $2,287,521. The firm will use straight-line depreciation to a value of $500,000 and assume the equipment will have a pre-tax salvage value of $469,308. They estimate revenue and costs for the project as presented in the table: Operating Year 1 2 3 4 5 Revenue $371,693 $861,893 $2,627,053 $1,047,316 $371,693 Costs $70,569 $330,987 $981,954 $246,165 $70,569 RocketOwl, Inc. expects the project will need initial inventory for the project of $107,528, and this amount will stay constant throughout the project. They also expect in the investment year the project will generate accounts receivable of $65,878 and accounts payable of $35,758. They also assume that the project will generate accounts payable each year equal to 0.19 of annual sales and accounts payable equal to 0.06 of…
Mike's landscaping is considering a new 4-year project. The necessary fixed assets will cost $157,000 and be depreciated on a 3-year MACRS and have no salvage value. The MACRS percentages each year are 33.33 percent, 44.45 percent, 14.81 percent, and 7.41 percent, respectively. The project will have annual sales of $98,000, variable costs of $27,400, and fixed costs of $12,000. The project will also require net working capital of $2,600 that will be returned at the end of the project. The company has a tax rate of 21 percent and the project's required return is 10 percent. What is the net present value of this project?
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