Warning Industries Is Considering Two Alternative Ways to Depreciate a Proposed

Warning Industries is considering two alternative ways to depreciate a proposed investment.The investment has an initial cost of $100,000 and an expected five-year life.The two alternative depreciation schedules follow:
$\begin{array}{llc}&\underline{\text { Method 1 }}&\underline{\text { Method2}} \\\text { Year } 1 \text { depreciation } & \$20,000&\$40,000 \\\text { Year 2 depreciation } & \$ 20,000 & \$ 30,000 \\\text { Year 3 depreciation } & \$ 20,000 & \$ 20,000 \\\text { Year 4 depreciation } & \$ 20,000 & \$ 10,000 \\\text { Year 5 depreciation } & \$ 20,000 & \$ 0\end{array}$

Assuming that the company faces a marginal tax rate of 40 percent and has a cost of capital of 10 percent,what is the difference between the two methods in the present value of the depreciation tax benefit? Present value tables or a financial calculator are required.

A) $7,196
B) $0
C) $2,878
D) $6,342

Correct Answer:

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