Reference no: EM132710364

A capital budgeting decision is being considered that would involve an expansion and simultaneous replacement of old equipment. The project is expected to have a 6 year life for the firm.

• This project will replace some existing equipment which currently has a book value (BV) of $200k and an estimated market salvage value of $375k. The new project will require new equipment costing $2000k, which will be depreciated straight-line to a book value of $200k at the end of 6 years. Due to new energy efficient technology, replacing the old equipment with the new more efficient equipment will generate an immediate tax credit of 5% of the equipment's cost. The expansion will require an additional investment in NWC of $200k.

• Sales are expected to increase by $1000k the first year and grow by 15% in years 2 and 3, then by 5% annually during the remaining 6 year life. Cost of goods sold is forecasted to be 45% of the increased sales, and other selling and general administrative expenses are forecasted to be 10% of the increased sales.
• It is forecasted that the new equipment will have a salvage value of $300k at the end of the project's 6 year life.
• The firm's weighted average cost of capital (WACC) for projects of this risk level is 8%. The firm's marginal tax rate is T = 40%.

Problem 1: What is the depreciation ?