Question

Universal Electronics is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12-11 to determine in what depreciation category the asset falls. (Hint: It is not 10 years.) The asset will cost \(120,000, and it will produce earnings before depreciation and taxes of \)37,000 per year for three years, and then $19,000 a year for seven more years. The firm has a tax rate of 40 percent. With a cost of capital of 12 percent, should it purchase the asset? Use the net present value method. In doing your analysis, if you have years in which there is no depreciation, merely enter a zero for depreciation.

Table 12-11 Categories for depreciation write-off
Class
3-year MACRS	All property with ADR midpoints of four years or less. Autos and light trucks are excluded from this category
5-year MACRS	Property with ADR midpoints of more than 4, but less than 10 years. Key assets in this category include automobiles, light trucks, and technological equipment such as computers and research-related properties
7-year MACRS	Property with ADR midpoints of 10 years or more, but less than 16 years. Most types of manufacturing equipment would fall into this category, as would office furniture and fixtures.
10-year MACRS	Property with ADR midpoints of 16 years or more, but less than 20 years. Petroleum refining products, railroad tank cars, and manufactured homes fall into this group.
15-year MACRS	Property with ADR midpoints of 20 years or more, but less than 25 years. Land improvement, pipeline distribution, telephone distribution, and sewage treatment plants all belong in this category
20-year MACRS	Property with ADR midpoints of 25 years or more (with the exception of real estate, which is treated separately). Key investments in this category include electric and gas utility property and sewer pipes.
27.5-year MACRS	Residential rental property if 80% or more of the gross rental income is from nontransient dwelling units (e.g., an apartment building); lowincome housing.
31.5-year MACRS	Nonresidential real property that has no ADR class life or whose class life is 27.5 years or more.
39-year MACRS	Nonresidential real property placed in service after May 12, 1993.

Short answer

The net present value is $6,262 and is recommended for approval.

Step-by-step solution

Meaning of MACRS.

The tax depreciation conspires in employed within the US is called MACRS. Modified Accelerated Cost Recovery Framework is known as MACRS. Concurring with MACRS, fixed assets are categorized into a certain asset lesson with a predetermined depreciation period.

Analysing whether an asset should be purchased or not

Given information:

• The initial investment in the equipment is $120,000
• The life of the project is 10 years
• In the depreciation category, the equipment falls if the equipment with a 10-year midpoint in its asset depreciation ranges (ADR) are 7 years- MARCS categories.
• Depreciation expense is calculated as per 7 years- MARCS category during the life of the project.

MARCS 7-Year Depreciation Schedule
Year	Capitalized cost	Depreciation rate	Depreciation expense
1	$120,000	0.143	$17,160
2	$120,000	0.245	$29,400
3	$120,000	0.175	$21,000
4	$120,000	0.125	$15,000
5	$120,000	0.089	$10,680
6	$120,000	0.089	$10,680
7	$120,000	0.089	$10,680
8	$120,000	0.045	$5,400
9	$120,000		$0.00
10	$120,000		$0.00
		100.00%	$120,000.00

• The earnings before depreciation and taxes of $37,000 per year for three years, and then $19,000 a year for seven more years.
• The tax rate is 40%
• The discount rate is 12%

The NPV is calculated below:

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10
Income Statement
Earning Before Tax Depreciation		$37,000	$37,000	$37,000	$19,000	$19,000	$19,000	$19,000	$19,000	19,000	$19,000
Depreciation		$17,160	$29,400	$21,000	$15,000	$10,680	$10,680	$10,680	$5,400	$0	$0
Earning Before Tax		$19,840	$7,600	$16,000	$4,000	$8,320	$8,320	$8,320	$13,600	$19,000	$19,000
Tax @40%		$7,936	$3,040	$6,400	$1,600	$3,328	$3,328	$3,328	$5,440	$7,600	$7,600
Net Income		$11,904	$4,560	$9,600	$2,400	$4,992	$4,992	$4,992	$8,160	$11,400	$11,400
Cash flow
Net income		$11,904	$4,560	$9,600	$2,400	$4,992	$4,992	$4,992	$8,160	$11,400	$11,400
Add: Depreciation		$17,160	$29,400	$21,000	$15,000	$10,680	$10,680	$10,680	$5,400	$0.00	$0.00
Initial Investment	-$120,000
Net cash Flow	-$120,000	$29,064	$33,960	$30,600	$17,400	$15,672	$15,672	$15,672	$13,560	$11,400	$11,400.00
PV factor @12%	1	0.893	0.798	0.711	0.636	0.567	0.507	0.452	0.404	0.361	0.321
PV of cash Flows	-$120,000	$25,954	$27,100	$21,756	$11,066	$8,886	$7,945	$7,084	$8,697	$4,115	$3,659
NPV	$6,262

It is advised that the $6,262 net present value be approved.