A financial analyst based in the United States has computed both accounting and NPV breakeven sales levels for a project under consideration using straight-line depreciation over a 6-year period. The project manager wants to know what will happen to these estimates if the firm uses depreciation calculated on the basis of the Modified Accelerated Cost Recovery System (MACRS). Firms in the United States are allowed by the Internal Revenue Service to depreciate their equipment for tax purposes using this system. The capital investment will be in a 5-year recovery period class under MACRS rules. Under the rules, applicable percentage depreciation rates over years 1 to 6 will be 20, 32, 19.20, 11.52, 11.52, and 5.76, so the firm will be able to use higher rates in earlier years. The firm is in a 35% tax bracket.
a. What (qualitatively) will happen to the accounting break-even level of sales in the first years of the project?
b. What (qualitatively) will happen to the NPV break-even level of sales?
c. If you were advising the analyst, would the answer to (a) or (b) be important to you? Specifically, would you say that the switch to MACRS makes the project more or less attractive?