P15-10 Various Depreciation Methods; Net Present Value

A Various Depreciation Methods; Net Present Value Walter Miller, manufacturing vice president of Atlantic Industries, has been anxious for some time to purchase a piece of high-pressure equipment for use in the company's coal liquefaction research project. The equipment would cost $720,000 and would have an eight-year useful life. It would have a salvage value equal to about 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 Mr. Miller has just received from his staff indicates that the equipment will not provide the 16% after-tax return required by Atlantic Industries. In making this analysis, Mr. Miller's staff 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 equipment would be the installation of new pressure seals in five years at a cost of $80,000. In doing the analysis, Mr. Miller had instructed his staff to depreciate the equipment by 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 done by Mr. Miller's staff, the company's controller has suggested that the analysis be redone using the MACRS tables rather than the optional straight-line method. Somewhat irritated by this suggestion, Mr. Miller replied, "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 optional straight-line method for computing depreciation as instructed by Mr. Miller