Sam is evaluating a capital budgeting project that should last for four years. The project requires $700,000 of equipment. He is unsure what depreciation method to use in her analysis, straight-line or the three-year MACRS accelerated method. Under straight-line depreciation, the cost of the equipment would be depreciated evenly over its four-year life (ignore the half-year convention for the straight-line method). The applicable MACRS depreciation rates are 33.33, 44.45, 14.81 and 7.41 percent. Assume that both straight-line and MACRS depreciation expenses begin in Year 1.

The companys required return on capital is 10%and its tax rate is 40%.

a. What would the depreciation expense be each year under each method?

b. Calculate the PV of the depreciation tax shield for both straight-line and MACRS. Which depreciation method produces the higher value? By how much?

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