Mel Ville, Executive Vice President of Moby Dick, Inc. has been anxious for some time to purchase a piece of high-pressure equipment for use in the company's blubber liquefaction research project. The equipment would cost $700,000 and is expected to have an eight-year useful life at which point it would be scrapped with a planned salvage value of $30,000.

An analysis that Mr. Ville has just received from his staff indicates that the equipment appears not to provide the required rate of return of 15% sought by Moby Dick, Inc. In making this analysis, Mr. Ville's staff estimated that the equipment would save the company $200,000 per year (in pre-tax cash operating profit) in its research program as a result of speeding up key processes. The only significant maintenance expense work required on the equipment would be the expected replacement of new pressure seals five years from now at a nominal maintenance cost of $20,000. Also in the analysis, Mr. Ville's staff depreciated the equipment by the optional straight-line method and used the equipment's eight-year life as the depreciation period, as permitted by the Internal Revenue Service (see table below), and as instructed by Mr. Ville himself. Additionally, inventory of $40,000 will have to be immediately committed, upon installation, to support the higher speed equipment. The company's marginal tax rate is 34%.

The controller of the company has told Mr. Ville that he should instruct his staff to use the more accelerated depreciation method as also allowed by the Internal Revenue Service (MACRS...see table below) to depreciate the equipment for capital budgeting purposes as well as encouraging the use of mid-year discounting Somewhat irritated by this suggestion, Mr. Ville replied..."You accountants and your fancy bookkeeping methods! What difference does it make what depreciation method we use or what discounting mechanism we use; we have the same investment, the same cost savings, and the same depreciation total eventually. This proposed equipment just doesn't measure up to our rate of return requirements. How you alter depreciation methods or discounted cash flows shouldnt change the outcome."

Straight-Line

Year Method MACRS

1 12.50% 14.29%

2 12.50% 24.49%

3 12.50% 17.49%

4 12.50% 12.49%

5 12.50% 8.93%

6 12.50% 8.93%

7 12.50% 8.93%

8 12.50% 4.45%

1. Compute the Net Present Value of the equipment, using the optional straight-line method for computing depreciation, as

instructed by Mr. Ville.

2. Compute the Net Present Value of the equipment, using the optional MACRS tables for computing depreciation, as

recommended by the controller.

3. Show Mr. Ville how the change in the depreciation method might just affect the investments outcome and its internal rate

of return.

4. Also, will the use of mid-year discounting work to the benefit of enhancing the value of the project. Show all required

calculations in defense of your strategy.