Wendy is evaluating a capital budgeting project that should last for 4 years. The project requires $800,000 of equipment. She is unsure what depreciation method to use in her analysis, 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%, 45%, 15%, and 7%, as discussed in Appendix 11A. 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?