(Depreciation; FV) Caldwell Consulting operates three offices in the Midwest. The firm is considering an investment in a new mainframe computer and communications software. The computer and software would cost $2,000,000 and have an expected life of eight years. For tax purposes, the investment will be depreciated using the straight-line method over five years, with no salvage value expected at the end of its life. The company’s cost of capital and tax rates are 10 percent and 40 percent, respectively.

a. Compute the present value of the depreciation tax benefit.

b. Assume instead that Caldwell uses the double-declining-balance method of depreciation with a five-year life. Compute the present value of the depreciation tax benefit.

c. Why is the depreciation tax benefit computed in part

(b) larger than that computed in part (a)?

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