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### Financial & Managerial Accounting

Book edition 7th
Author(s) John J Wild, Ken W. Shaw, Barbara Chiappetta
Pages 1096 pages
ISBN 9781259726705

# Manning 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. Straight-Line 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$90,000Required 1. Prepare a five-column table that reports amounts (assuming use of straight-line depreciation) for each of the following for each of the six years: (a) pretax income before depreciation, (b) straight-line 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 five-column 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 straight-line 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.

See the step by step solution

## Step-by-Step SolutionStep 1: Preparation of table using straight-line depreciation

 Year Income before depreciation Straight-line 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

## Step 5: MACRS depreciation increases the NPV of the project

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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