Concept explainers
Concept Introduction:
NPV:
Requirement-1:
To determine: The Net
Answer to Problem 3BPSB
Solution: The Net cash flows using the straight line method of depreciation are as follows:
| Year | (e) Net Cash Flows |
| 1 | $ 8,400 |
| 2 | $ 9,600 |
| 3 | $ 9,600 |
| 4 | $ 9,600 |
| 5 | $ 9,600 |
| 6 | $ 8,400 |
Explanation of Solution
Explanation: The Net cash flows using the straight line method of depreciation are explained as follows:
| Year | (a) Pretax Income before depreciation | (b) Straight Line Depreciation expense | (c) Taxable Income | (d) Income Taxes | (e) Net Cash Flows |
| c =a-b | d=c*40% | e=a-d | |||
| 1 | $ 12,000 | $ 3,000 | $ 9,000 | $ 3,600 | $ 8,400 |
| 2 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 |
| 3 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 |
| 4 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 |
| 5 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 |
| 6 | $ 12,000 | $ 3,000 | $ 9,000 | $ 3,600 | $ 8,400 |
Conclusion:
Hence, the net cash flows are calculated using the straight line method of depreciation.
Requirement-2:
To determine: The Net cash flows using the MACRS method of depreciation.
Answer to Problem 3BPSB
Solution: The Net cash flows using the MACRS method of depreciation are as follows:
| Year | (e) Net Cash Flows |
| 1 | $ 9,600 |
| 2 | $ 11,040 |
| 3 | $ 9,504 |
| 4 | $ 8,582 |
| 5 | $ 8,582 |
| 6 | $ 7,891 |
Explanation of Solution
Explanation: The Net cash flows using the MACRS method of depreciation are explained as follows:
| Year | (a) Pretax Income before depreciation | (b) MACRS Depreciation expense | (c) Taxable Income | (d) Income Taxes | (e) Net Cash Flows |
| c =a-b | d=c*40% | e=a-d | |||
| 1 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 |
| 2 | $ 12,000 | $ 9,600 | $ 2,400 | $ 960 | $ 11,040 |
| 3 | $ 12,000 | $ 5,760 | $ 6,240 | $ 2,496 | $ 9,504 |
| 4 | $ 12,000 | $ 3,456 | $ 8,544 | $ 3,418 | $ 8,582 |
| 5 | $ 12,000 | $ 3,456 | $ 8,544 | $ 3,418 | $ 8,582 |
| 6 | $ 12,000 | $ 1,728 | $ 10,272 | $ 4,109 | $ 7,891 |
Conclusion:
Hence, the net cash flows are calculated using the MACRS method of depreciation.
Requirement-3:
To determine: The Net Present value of the investment using the Straight line method of depreciation.
Answer to Problem 3BPSB
Solution: The Net Present value of the investment using the Straight line method of depreciation is $10,041
Explanation of Solution
Explanation: The Net Present value of the investment using the Straight line method of depreciation is calculated as follows:
| Year | (a) Pretax Income before depreciation | (b) Straight Line Depreciation expense | (c) Taxable Income | (d) Income Taxes | (e) Net Cash Flows | PVF (10%) | PV |
| c =a-b | d=c*40% | e=a-d | f | e*f | |||
| 1 | $ 12,000 | $ 3,000 | $ 9,000 | $ 3,600 | $ 8,400 | 0.9091 | $ 7,636 |
| 2 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 | 0.8264 | $ 7,933 |
| 3 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 | 0.7513 | $ 7,212 |
| 4 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 | 0.6830 | $ 6,557 |
| 5 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 | 0.6209 | $ 5,961 |
| 6 | $ 12,000 | $ 3,000 | $ 9,000 | $ 3,600 | $ 8,400 | 0.5645 | $ 4,742 |
| Present value of Cash inflows | $ 40,041 | ||||||
| Less: Initial Investment | $ (30,000) | ||||||
| Net present value (NPV) | $ 10,041 | ||||||
Conclusion:
Hence, the Net Present value of the investment using the Straight line method of depreciation is $10,041
Requirement-4:
To determine: The Net Present value of the investment using the MACRS method of depreciation.
Answer to Problem 3BPSB
Solution: The Net Present value of the investment using the MACRS method of depreciation is $10,635
Explanation of Solution
Explanation: The Net Present value of the investment using the MACRS method of depreciation is calculated as follows:
| Year | (a) Pretax Income before depreciation | (b) MACRS Depreciation expense | (c) Taxable Income | (d) Income Taxes | (e) Net Cash Flows | PVF (10%) | PV |
| c =a-b | d=c*40% | e=a-d | f | e*f | |||
| 1 | $ 12,000 | $ 6,000 | $ 6,000 | $ 2,400 | $ 9,600 | 0.9091 | $ 8,727 |
| 2 | $ 12,000 | $ 9,600 | $ 2,400 | $ 960 | $ 11,040 | 0.8264 | $ 9,123 |
| 3 | $ 12,000 | $ 5,760 | $ 6,240 | $ 2,496 | $ 9,504 | 0.7513 | $ 7,140 |
| 4 | $ 12,000 | $ 3,456 | $ 8,544 | $ 3,418 | $ 8,582 | 0.6830 | $ 5,862 |
| 5 | $ 12,000 | $ 3,456 | $ 8,544 | $ 3,418 | $ 8,582 | 0.6209 | $ 5,329 |
| 6 | $ 12,000 | $ 1,728 | $ 10,272 | $ 4,109 | $ 7,891 | 0.5645 | $ 4,455 |
| Present value of Cash inflows | $ 40,635 | ||||||
| Less: Initial Investment | $ (30,000) | ||||||
| Net present value (NPV) | $ 10,635 | ||||||
Conclusion:
Hence, the Net Present value of the investment using the MACRS method of depreciation is $10.635
Requirement-5:
To state: The reason of increase in Net Present value using the MACRS method of depreciation.
Answer to Problem 3BPSB
Solution: The reason of increase in Net Present value using the MACRS method of depreciation is the higher amount of depreciation in earlier years of the project.
Explanation of Solution
Explanation: The MACRS method depreciates the asset using the higher rate in the beginning years of the life of the assets which results in higher depreciation expense and lower income tax. Hence, the net cash flows and Net present value using the MACRS depreciation method are higher than using the straight line depreciation method.
Conclusion: Hence, the reason of increase in Net Present value using the MACRS method of depreciation is the higher amount of depreciation in earlier years of the project.
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