P$14$C$-$H$2$

The CEO of UML, Inc. wants to purchase a piece of special equipment for use in the company's

environmental research project. The equipment would cost $$720,000$ and would have an eight$-$year

useful life and a salvage value equal to $5\%$ of its original cost. In addition to the cost of the equipment,

the company would have to increase its working capital by $$10,000$ to handle the more rapid processing

of material by the new equipment.

An analysis that the CEO has just received indicates that the equipment will not provide the required

$16\%$ after$-$tax return. The analysis estimated that the equipment would save the company $$200,000$ per

year in its research program as a result of speeding up several key processes. The only significant

maintenance work required on the new equipment would be the installation of new pressure seals in five

years at a cost of $$80,000.$ The CEO instructed that the new equipment be depreciated using the

MACRS optional straight$-$line method, since the company always uses straight$-$line depreciation for

accounting purposes. The company's tax rate is $30\%.$ The equipment is in the MACRS five$-$year

property class.

Upon seeing the analysis, the company's controller has suggested that the analysis be redone using

the regular MACRS tables rather than the MACRS optional straight$-$line method. Somewhat

irritated by this suggestion, the CEO stated, "You accountants and your fancy bookkeeping

methods! What difference does it make what depreciation method we use $-$ we have the same

investment, the same cost savings, and the same total depreciation either way. That equipment just

doesn't measure up to our rate of return requirements. How you make the bookkeeping entries for

depreciation won't change that fact."

Required $1.$ Compute the net present value of the equipment using the MACRS optional straight$-$line

method for computing depreciation as instructed by the CEO.

Compute the net present value of the equipment using the regular MACRS tables as

suggested by the controller. Round all dollar amounts to the nearest whole dollar.

Explain to the CEO how the tax depreciation method used can affect the rate of

return generated by an investment project.