PHP inc. is considering purchasing a security system costing $642,000. The equipment will be...

Question:

PHP inc. is considering purchasing a security system costing $642,000. The equipment will be depreciated as 5-year property under MACRS, which provides for depreciation allowance percentages of 20%, 32%, 19.20%, 11.52%, 11.52%, and 5.76% respectively for each of the five years. What is the anticipated tax shield in year three on this equipment if the company is in the 34% marginal tax bracket?

Tax Shield:

In the capital budgeting exercise, the cash flows are calculated for the projects, and the tax shield pays a major role in the cost of the project in terms of tax outgo. A tax Shield is an allowable deduction from the taxable income that results in a reduction of taxes owed.

Answer and Explanation:

Information required calculating the tax shield in the 3rd year

  • The cost of security system is $642,000
  • The depreciation rate is 19.20% in year 3
  • The tax rate is 34%

Tax Shield = Depreciation expense x Tax Rate
= (Purchase cost x depreciation rate in year 3) x Tax rate
= ($642,000 x 19.20%) x 34%
= $123,264 x 34%
=$41,909.76 or $41,910 (rounding off nearest dollar)

The anticipated tax shield in year three on this equipment is $41,910


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