Q3PSA
ExpertverifiedManning Corporation is considering a new project requiring a $90,000 investment in test equipment with no salvage value. The project would produce $66,000 of pretax income before depreciation at the end of each of the next six years. The company’s income tax rate is 40%. In compiling its tax return and computing its income tax payments, the company can choose between the two alternative depreciation schedules shown in the table.
StraightLine MACRS
Depreciation Depreciation*
Year 1 . . . . . . . . . . $ 9,000 $18,000
Year 2 . . . . . . . . . . 18,000 28,800
Year 3 . . . . . . . . . . 18,000 17,280
Year 4 . . . . . . . . . . 18,000 10,368
Year 5 . . . . . . . . . . 18,000 10,368
Year 6 . . . . . . . . . . 9,000 5,184
Totals . . . . . . . . . . . $90,000 $90,000
Required
1. Prepare a fivecolumn table that reports amounts (assuming use of straightline depreciation) for each of the following for each of the six years: (a) pretax income before depreciation, (b) straightline depreciation expense, (c) taxable income, (d) income taxes, and (e) net cash flow. Net cash flow equals the amount of income before depreciation minus the income taxes. (Round answers to the nearest dollar.)
2. Prepare a fivecolumn table that reports amounts (assuming use of MACRS depreciation) for each of the following for each of the six years: (a) pretax income before depreciation, (b) MACRS depreciation expense, (c) taxable income, (d) income taxes, and (e) net cash flow. Net cash flow equals the income amount before depreciation minus the income taxes. (Round answers to the nearest dollar.)
3. Compute the net present value of the investment if straightline depreciation is used. Use 10% as the discount rate. (Round the net present value to the nearest dollar.)
4. Compute the net present value of the investment if MACRS depreciation is used. Use 10% as the discount rate. (Round the net present value to the nearest dollar.)
Analysis Component
5. Explain why the MACRS depreciation method increases this project’s net present value.
The net cash flows are computed using both methods. The NPV using a straight line is $108,518 and NPV using MACRS is $110,303. MACRS shows an increased NPV because of the increased cash inflows.
Year  Income before depreciation  Straightline depreciation  Taxable Income  Income Taxes  Net Cashflows 
Year 1  $66,000  $9,000  $57,000  $22,800  43,200 
Year 2  66,000  18,000  48,000  19,200  46,800 
Year 3  66,000  18,000  48,000  19,200  46,800 
Year 4  66,000  18,000  48,000  19,200  46,800 
Year 5  66,000  18,000  48,000  19,200  46,800 
Year 6  66,000  9,000  57,000  22,800  43,200 
Year  Income before depreciation  Straightline depreciation  Taxable Income  Income Taxes  Net Cashflows 






Year 1  $66,000  $18,000  $48,000  $19,200  $46,800 
Tear 2  66,000  28,800  37,200  14,880  51,120 
Year 3  66,000  17,280  48,720  19,488  46,512 
Year 4  66,000  10,368  55,632  22,253  43,747 
Year 5  66,000  10,368  55,632  22,253  43,747 
Year 6  66,000  5,184  60,816  24,326  41,674 
Charts Values are based on:  
I = 10%  
Year  Net Cash Inflow  X  PV Factor  =  Present Value 
1  43,200  X  0.9091  =  39,273 
2  46,800  X  0.8264  =  38,676 
3  46,800  X  0.7513  =  35,161 
4  46,800  X  0.6830  =  31,964 
5  46,800  X  0.6209  =  29,058 
6  43,200  X  0.5645  =  24,386 
Present Value of cash inflows  $198,518 
Present Value of cash outflows  90,000 
Net present value  $108,518 
Charts Values are based on:  
I = 10%  
Year  Net Cash Inflow  X  PV Factor  =  Present Value 
1  46,800  X  0.9091  =  42,546 
2  51,120  X  0.8264  =  42,246 
3  46,512  X  0.7513  =  34,944 
4  43,747  X  0.6830  =  29,879 
5  43,747  X  0.6209  =  27,163 
6  41,674  X  0.5645  =  23,525 
Present Value of cash inflows  $200,303  
Present Value of cash outflows  90,000  
Net present value  $110,303 
The MACRS depreciation method increases the net present value of the project as shows higher depreciation in the early years which leads to an increase in the cash inflows. So, MACRS depreciation increases the NPV of the project.
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