Daily Enterprises is purchasing a $10.5 million machine. It will cost $52,000 to transport and install the machine. The machine has a depreciable life of 55 years, is using straight-line depreciation, and will have no salvage value. The machine will generate incremental revenues of $3.8 million per year along with incremental costs of $1.25 million per year. Daily's marginal tax rate is 21%. You are forecasting incremental free cash flows for Daily Enterprises.

a. If Daily Enterprises decides to use MACRS instead of straight-line depreciation, how would the incremental free cash flows associated with the new machine change?

b. Under the TCJA of 2017, Daily Enterprises has the option to take 100% "Bonus" depreciation in the year in which the equipment is put into use. This means that in that year, it would take the full depreciation expense equivalent to the cost of buying the equipment. If Daily does so, which cash flows would increase and which would decrease? How does this compare to MACRS?

a. If Daily Enterprises decides to use MACRS instead of straight-line depreciation, how would the incremental free cash flows associated with the new machine change?

"The incremental cash flows would increase in years 0 and 1, as the accelerated depreciation schedule would give Daily Enterprises a higher tax shield during those two years. In years 2 through 5, the incremental free cash flows would be lower, since the depreciation expenses in these years are lower than 20%. Overall, the present value of the free cash flows would increase under a MACRS depreciation schedule."

Is the above statement true or false?

False

True

.(Select from the drop-down menu.)

b. Under the TCJA of 2017, Daily Enterprises has the option to take 100% "Bonus" depreciation in the year in which the equipment is put into use. This means that in that year, it would take the full depreciation expense equivalent to the cost of buying the equipment. If Daily does so, which cash flows would increase and which would decrease? How does this compare to MACRS?(Select all the choices that apply.)

A.In the case of Daily Enterprises, we assume that it puts the machine into use immediately, as seen by the MACRS expense in year 0. Thus, Daily would take 100% of the depreciation expense in year 0 so that the entire cost of the equipment is deducted from taxes that year.

B.With its taxes reduced, the incremental cash flow in year 0 is increased. With 100% of the depreciation expense used in year 0, Daily would have no incremental depreciation in years 1 through 6. However, by accelerating the entire tax deduction to year 0, the present value of the incremental free cash flows would increase under bonus depreciation.

C.Compared to MACRS, the effect will be less dramatic, but similar. MACRS puts more than half of the depreciation in years 0 and 1 (20% + 19.20%), whereas bonus depreciation puts 100% in year 0. Thus, again the incremental free cash flow will be higher in year 0, but lower in years 1 through 5, and the present value of those cash flows will be greater.

D.Compared to MACRS, the effect will be less dramatic, but similar. MACRS puts more than half of the depreciation in years 0 and 1 (20% + 32%), whereas bonus depreciation puts 100% in year 0. Thus, again the incremental free cash flow will be higher in year 0, but lower in years 1 through 5, and the present value of those cash flows will be greater.