Chapter 25, Problem 3BPSB

To determine

Concept Introduction:

NPV: Net present value (NPV) is the method to evaluate the project feasibility. This method calculates the present value of cash inflows and outflows, and then calculates the net present value of the investment. A project should be accepted if it has a positive NPV. The formula to calculate the NPV is as follows:

$NPV= Presentvalueofcashinflows–Presentvalueofcashoutflows$

Requirement-1:

To determine: The Net cash flows using the straight line method of depreciation.

Answer to Problem 3BPSB

Solution: The Net cash flows using the straight line method of depreciation are as follows:

Year	(e) Net Cash Flows
1	$ 8,400
2	$ 9,600
3	$ 9,600
4	$ 9,600
5	$ 9,600
6	$ 8,400

Explanation of Solution

Explanation: The Net cash flows using the straight line method of depreciation are explained as follows:

Year	(a) Pretax Income before depreciation	(b) Straight Line Depreciation expense	(c) Taxable Income	(d) Income Taxes	(e) Net Cash Flows
			c =a-b	d=c*40%	e=a-d
1	$ 12,000	$ 3,000	$ 9,000	$ 3,600	$ 8,400
2	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600
3	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600
4	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600
5	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600
6	$ 12,000	$ 3,000	$ 9,000	$ 3,600	$ 8,400

Conclusion

Conclusion:

Hence, the net cash flows are calculated using the straight line method of depreciation.

To determine

Requirement-2:

To determine: The Net cash flows using the MACRS method of depreciation.

Answer to Problem 3BPSB

Solution: The Net cash flows using the MACRS method of depreciation are as follows:

Year	(e) Net Cash Flows
1	$ 9,600
2	$ 11,040
3	$ 9,504
4	$ 8,582
5	$ 8,582
6	$ 7,891

Explanation of Solution

Explanation: The Net cash flows using the MACRS method of depreciation are explained as follows:

Year	(a) Pretax Income before depreciation	(b) MACRS Depreciation expense	(c) Taxable Income	(d) Income Taxes	(e) Net Cash Flows
			c =a-b	d=c*40%	e=a-d
1	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600
2	$ 12,000	$ 9,600	$ 2,400	$ 960	$ 11,040
3	$ 12,000	$ 5,760	$ 6,240	$ 2,496	$ 9,504
4	$ 12,000	$ 3,456	$ 8,544	$ 3,418	$ 8,582
5	$ 12,000	$ 3,456	$ 8,544	$ 3,418	$ 8,582
6	$ 12,000	$ 1,728	$ 10,272	$ 4,109	$ 7,891

Conclusion

Conclusion:

Hence, the net cash flows are calculated using the MACRS method of depreciation.

To determine

Requirement-3:

To determine: The Net Present value of the investment using the Straight line method of depreciation.

Answer to Problem 3BPSB

Solution: The Net Present value of the investment using the Straight line method of depreciation is $10,041

Explanation of Solution

Explanation: The Net Present value of the investment using the Straight line method of depreciation is calculated as follows:

Year	(a) Pretax Income before depreciation	(b) Straight Line Depreciation expense	(c) Taxable Income	(d) Income Taxes	(e) Net Cash Flows	PVF (10%)	PV
			c =a-b	d=c*40%	e=a-d	f	e*f
1	$ 12,000	$ 3,000	$ 9,000	$ 3,600	$ 8,400	0.9091	$ 7,636
2	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600	0.8264	$ 7,933
3	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600	0.7513	$ 7,212
4	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600	0.6830	$ 6,557
5	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600	0.6209	$ 5,961
6	$ 12,000	$ 3,000	$ 9,000	$ 3,600	$ 8,400	0.5645	$ 4,742
Present value of Cash inflows							$ 40,041
Less: Initial Investment							$ (30,000)
Net present value (NPV)							$ 10,041

Conclusion

Conclusion:

Hence, the Net Present value of the investment using the Straight line method of depreciation is $10,041

To determine

Requirement-4:

To determine: The Net Present value of the investment using the MACRS method of depreciation.

Answer to Problem 3BPSB

Solution: The Net Present value of the investment using the MACRS method of depreciation is $10,635

Explanation of Solution

Explanation: The Net Present value of the investment using the MACRS method of depreciation is calculated as follows:

Year	(a) Pretax Income before depreciation	(b) MACRS Depreciation expense	(c) Taxable Income	(d) Income Taxes	(e) Net Cash Flows	PVF (10%)	PV
			c =a-b	d=c*40%	e=a-d	f	e*f
1	$ 12,000	$ 6,000	$ 6,000	$ 2,400	$ 9,600	0.9091	$ 8,727
2	$ 12,000	$ 9,600	$ 2,400	$ 960	$ 11,040	0.8264	$ 9,123
3	$ 12,000	$ 5,760	$ 6,240	$ 2,496	$ 9,504	0.7513	$ 7,140
4	$ 12,000	$ 3,456	$ 8,544	$ 3,418	$ 8,582	0.6830	$ 5,862
5	$ 12,000	$ 3,456	$ 8,544	$ 3,418	$ 8,582	0.6209	$ 5,329
6	$ 12,000	$ 1,728	$ 10,272	$ 4,109	$ 7,891	0.5645	$ 4,455
Present value of Cash inflows							$ 40,635
Less: Initial Investment							$ (30,000)
Net present value (NPV)							$ 10,635

Conclusion

Conclusion:

Hence, the Net Present value of the investment using the MACRS method of depreciation is $10.635

To determine

Requirement-5:

To state: The reason of increase in Net Present value using the MACRS method of depreciation.

Answer to Problem 3BPSB

Solution: The reason of increase in Net Present value using the MACRS method of depreciation is the higher amount of depreciation in earlier years of the project.

Explanation of Solution

Explanation: The MACRS method depreciates the asset using the higher rate in the beginning years of the life of the assets which results in higher depreciation expense and lower income tax. Hence, the net cash flows and Net present value using the MACRS depreciation method are higher than using the straight line depreciation method.

Conclusion

Conclusion: Hence, the reason of increase in Net Present value using the MACRS method of depreciation is the higher amount of depreciation in earlier years of the project.