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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

# Grossman Corporation is considering a new project requiring a $30,000 investment in an asset having no salvage value. The project would produce$12,000 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 two alternative depreciation schedules as shown in the table. Straight-Line MACRS Depreciation Depreciation* Year 1 . . . . . . . . . . $3,000$6,000Year 2 . . . . . . . . . . 6,000 9,600 Year 3 . . . . . . . . . . 6,000 5,760 Year 4 . . . . . . . . . . 6,000 3,456 Year 5 . . . . . . . . . . 6,000 3,456 Year 6 . . . . . . . . . . 2,000 1,728 Totals . . . . . . . . . . . $30,000$30,000Required 1. Prepare a five-column table that reports amounts (assuming use of straight-line depreciation) for each of the following items 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 items 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 amount of income 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 the net present value of this project.

The net cash flows are computed using both methods. The NPV using a straight line is $10,041 and NPV using MACRS is$10,635. MACRS shows an increased NPV because of the increased cash inflows.

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## Step 3: Computation of net present value (Straight-line method)

 Charts Values are based on: I = 10% Year Net Cash Inflow X PV Factor = Present Value 1 8,400 X 0.9091 = 7,636 2 9,600 X 0.8264 = 7,933 3 9,600 X 0.7513 = 7,212 4 9,600 X 0.6830 = 6,557 5 9,600 X 0.6209 = 5,961 6 8,400 X 0.5645 = 4,742 Present Value of cash inflows $40,041 Present Value of cash outflows -30,000 Net present value$10,041

## Step 4: Computation of net present value (MACRS)

 Charts Values are based on: I = 10% Year Net Cash Inflow X PV Factor = Present Value 1 $9,600 X 0.9091 = 8,727 2 11,040 X 0.8264 = 9,123 3 9,504 X 0.7513 = 7,140 4 8,582 X 0.6830 = 5,862 5 8,582 X 0.6209 = 5,329 6 7,891 X 0.5645 = 4,454 Present Value of cash inflows$40,635 Present Value of cash outflows -30,000 Net present value \$10,635

## 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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