Q3PSB
ExpertverifiedGrossman 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.
StraightLine MACRS
Depreciation Depreciation*
Year 1 . . . . . . . . . . $ 3,000 $6,000
Year 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 $30,000
Required
1. Prepare a fivecolumn table that reports amounts (assuming use of straightline depreciation) for each of the following items 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 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 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 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.
Year  Income before depreciation  Straightline depreciation  Taxable Income  Income Taxes  Net Cashflows 
Year 1  $12,000  $3,000  $9,000  $3,600  $8,400 
Year 2  12,000  6,000  6,000  2,400  9,600 
Year 3  12,000  6,000  6,000  2,400  9,600 
Year 4  12,000  6,000  6,000  2,400  9,600 
Year 5  12,000  6,000  6,000  2,400  9,600 
Year 6  12,000  3,000  9,000  3,600  8,400 
Year  Income before depreciation  Straightline depreciation  Taxable Income  Income Taxes  Net Cashflows 






Year 1  $12,000  $6,000  $6,000  $2,400  $9,600 
Tear 2  12,000  9,600  2,400  960  11,040 
Year 3  12,000  5,760  6,240  2,496  9,504 
Year 4  12,000  3,456  8,544  3,418  8,582 
Year 5  12,000  3,456  8,544  3,418  8,582 
Year 6  12,000  1,728  10,272  4,109  7,891 
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 
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 
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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