Question content area top

Part 1

Markov Manufacturing recently spent

$16.8

million to purchase some equipment used in the manufacture of disk drives. The firm expects that this equipment will have a useful life of five years, and its marginal corporate tax rate is

21%.

The company plans to use straight-line depreciation.

a. What is the annual depreciation expense associated with this equipment?

b. What is the annual depreciation tax shield?

c. Rather than straight-line depreciation, suppose Markov will use the MACRS depreciation method for the five-year life of the property. Calculate the depreciation tax shield each year for this equipment under this accelerated depreciation schedule.

d. If Markov has a choice between straight-line and MACRS depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which schedule should it choose? Why?

e. How might your answer to part

(d)

change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years?

f. Under the TCJA of 2017, Markov 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, Markov would take the full depreciation expense equivalent to the cost of buying the equipment. Rather than straight-line depreciation, suppose Markov will use the bonus depreciation method. Calculate the depreciation tax shield each year for this equipment with bonus depreciation.

g. If Markov has a choice between straight-line, MACRS and bonus depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which schedule should it choose? Why?

h. How might your answer to part

(g)

change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years?

Note:

Assume that the equipment is put into use in year 1.

Question content area bottom

Part 1

a. What is the annual depreciation expense associated with this equipment?

The annual depreciation expense is

$enter your response here

million. (Round to three decimal places.)

Part 2

b. What is the annual depreciation tax shield?

The annual depreciation tax shield is

$enter your response here

million. (Round to three decimal places.)

Part 3

c. Rather than straight-line depreciation, suppose Markov will use the MACRS depreciation method for the five-year life of the property. Calculate the depreciation tax shield each year for this equipment under this accelerated depreciation schedule.

The depreciation tax shield for year 1 is

$enter your response here

million.(Round to three decimal places.)

Part 4

The depreciation tax shield for year 2 is

$enter your response here

million.(Round to three decimal places.)

Part 5

The depreciation tax shield for year 3 is

$enter your response here

million.(Round to three decimal places.)

Part 6

The depreciation tax shield for year 4 is

$enter your response here

million.(Round to three decimal places.)

Part 7

The depreciation tax shield for year 5 is

$enter your response here

million.(Round to three decimal places.)

Part 8

The depreciation tax shield for year 6 is

$enter your response here

million.(Round to three decimal places.)

Part 9

d. If Markov has a choice between straight-line and MACRS depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which schedule should it choose? Why? (Select the best choice below.)

A.

The straight-line depreciation is recommended only for assets that last more than 5 years.

B.

With MACRS, the firm receives the depreciation tax shields sooner. Thus, MACRS depreciation leads to a higher NPV of Markov's FCF.

C.

With straight-line depreciation, the firm's depreciation expenses are lower initially, leading to higher earnings. Thus, straight-line depreciation leads to a higher NPV of Markov's FCF.

D.

With either method, the total depreciation tax shield is the same. Therefore, it does not matter which method is used.

Part 10

e. How might your answer to part

(d)

change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years?(Select the best choice below.)

A.

Markov may be better off using the straight-line method if it expects its tax rate to decrease substantially in later years.

B.

Even if its tax rate is expected to change, Markov is better off using MACRS depreciation rather than straight-line depreciation.

C.

Markov may be better off using the straight-line method if it expects its tax rate to increase substantially in later years.

D.The straight-line depreciation is recommended only for companies whose tax rates are higher than

21%.

Part 11

f. Under the TCJA of 2017, Markov 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, Markov would take the full depreciation expense equivalent to the cost of buying the equipment. Rather than straight-line depreciation, suppose Markov will use the bonus depreciation method. Calculate the depreciation tax shield each year for this equipment with bonus depreciation.

The depreciation tax shield for year 1 is

$enter your response here

million.(Round to three decimal places.)

Part 12

The depreciation tax shield for years 2-6 is

$enter your response here

million.(Round to three decimal places.)

Part 13

g. If Markov has a choice between straight-line, MACRS and bonus depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which schedule should it choose? Why?(Select the best choice below.)

A.In all cases, its total depreciation tax shield is the same. But with bonus depreciation, it receives the entire depreciation tax shield in year

1thus,

bonus depreciation leads to a higher NPV of Markov's FCF.

B.In all cases, its total depreciation tax shield is the same. But with bonus depreciation, it receives the entire depreciation tax shield in year

3thus,

bonus depreciation leads to a higher NPV of Markov's FCF.

C.In all cases, its total depreciation tax shield is the same. But with bonus depreciation, it receives the entire depreciation tax shield in year

2thus,

bonus depreciation leads to a higher NPV of Markov's FCF.

D.In all cases, its total depreciation tax shield is the same. But with bonus depreciation, it receives the entire depreciation tax shield in year

0thus,

bonus depreciation leads to a higher NPV of Markov's FCF.

Part 14

h. How might your answer to part

(g)

change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years?(Select from the drop-down menus.)As in the case of MACRS, if the tax rate will increase substantially, then Markov may be better off claiming

higher

lower

depreciation expenses in

later

early

years because the tax benefit at that time will be greater.