Copyright

A firm plans to purchase a $50,000 asset that will be depreciated straight-line over a 5-year...

Question:

A firm plans to purchase a $50,000 asset that will be depreciated straight-line over a 5-year life to a zero salvage value.

What is the present value of the resulting benefit from depreciation (the depreciation "tax shield") if the tax rate is 35% and the discount rate is 10%?

a. $10,866.67

b. $13,267.75

c. $17,500.00

d. $37,908.18

Tax Shield:

The tax shield is an important component in the project cash flows and the project cost. The cash outflows is considered as allowable expenses in the calculation of taxable income and the tax shield converts into less tax outgo in the project

Answer and Explanation:

Calculation of Tax Shield:

  • The purchase cost of asset is $50,000
  • The useful life is 5 years
  • The straight line depreciation method is considered

Depreciation expense per year = Capitalized cost of asset / Useful life of asset
= $50,000 / 5
=$10,000

  • The depreciation expense for year is $10,000
  • The Tax rate is 35%

Tax Shield = Depreciation expense x Tax Rate
= $10,000 x 35%
=$3,500

The tax shield is on deprecation is $3,500 per year

  • The discount rate is 10%

Using the present value table for an annuity at a 10% interest rate at the end of 5 years the Present value factor is 3.79079

The present value of Tax shield = Tax shield per year x present value annuity factor at 10%, 5 years
=$3,500 x 3.79079
=$ 13,267.765

The answer is B


Learn more about this topic:

Loading...
Operating Cash Flow: Definition & Examples

from Finance 101: Principles of Finance

Chapter 10 / Lesson 4
9.6K

Related to this Question

Explore our homework questions and answers library