J. Smythe, Inc., manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for $6,300, including a set of eight chairs. The company feels that sales will be 2,000, 2,150, 2,700, 2,550, and 2,300 sets per year for the next five years, respectively. Variable costs will amount to 42 percent of sales, and fixed costs are $1.81 million per year. The new dining room table sets will require inventory amounting to 7 percent of sales, produced and stockpiled in the year prior to sales. It is believed that the addition of the new table will cause a loss of sales of 300 dining room table sets per year of the oak tables the company produces. These tables sell for $3,600 and have variable costs of 37 percent of sales. The inventory for this oak table is also 7 percent of sales. The company believes that sales of the oak table will be discontinued after three years. J. Smythe currently has excess production capacity. If the company buys the necessary equipment today, it will cost $16 million. However, the excess production capacity means the company can produce the new table without buying the new equipment. The company controller has said that the current excess capacity will end in two years with current production. This means that if the company uses the current excess capacity for the new table, it will be forced to spend the $16 million in two years to accommodate the increased sales of its current products. In five years, the new equipment will have a market value of $3.3 million if purchased today, and $6.6 million if purchased in two years. The equipment is depreciated on a seven-year MACRS schedule. The company has a tax rate of 40 percent, and the required return for the project is 9 percent.

TABLE 8.3 Depreciation under Modified Accelerated Cost Recovery System (MACRS) RECOVERY PERIOD CLASS 5 YEARS 7 YEARS 10 YEARS YEAR 3 YEARS 15 YEARS 20 YEARS 1 .3333 4445 .1481 0741 .2000 .3200 .1920 .1152 1152 .0576 .1429 2449 .1749 .1249 0893 .0892 .0893 .0446 .1000 1800 1440 .1152 .0922 .0737 .0655 .0655 .0656 .0655 .0328 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 .0500 .0950 .0855 .0770 .0693 .0623 .0590 .0590 .0591 .0590 .0591 .0590 .0591 .0590 .0591 .0295 .03750 .07219 .06677 .06177 .05713 .05285 .04888 .04522 .04462 .04461 .04462 .04461 04462 .04461 .04462 .04461 .04462 .04461 .04462 .04461 .02231 Depreciation is expressed as a percent of the asset's cost. These schedules are based on the IRS publication 946. How to Depreciate Property and other details on depreciation are presented later in the chapter. Note that five-year depreciation actually carries over six years because the IRS assumes purchase is made in midyear