NPV with Income Taxes: Straight-Line versus Accelerated Depreciation (LO2, 6)

John Paul Jones Inc. is a conservatively managed boat company whose motto is, “The old ways are the good ways.” Management has always used straight-line depreciation for tax and external reporting purposes. Although they are reluctant to change, they are aware of the impact of taxes on a project's profitability.

Required For a typical $100,000 investment in equipment with a five-year life and no salvage value, determine the present value of the advantage resulting from the use of double-declining balance depreciation as opposed to straight-line depreciation. Assume an income tax rate of 40 percent and a discount rate of 16 percent. Also assume that there will be a switch from double-declining balance to straight-line depreciation in the fourth year.

 LO.1