Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just

Question

Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just ordered a new kiln for $530,000. Of this sum, $63,000 is described by the supplier as an installation cost. Ms. Potts does not know whether the Internal Revenue Service (IRS) will permit the company to treat this cost as a tax-deductible first-year deductible expense or as a capital investment. In the latter case, the company could depreciate the $63,000 using the five-year MACRS tax depreciation schedule.

Assume the tax rate is 40% and the opportunity cost of capital is 8%. Calculate the value of the tax shield 1 and tax shield 2. (Note: Use Tax shield 1 as an expense treatment and tax shield 2 as 5 year MACRS.)

Assume the tax rate is 40% and the opportunity cost of capital is 8%. Calculate the value of the tax shield 1 and tax shield 2. (Note: Use Tax shield 1 as an expense treatment and tax shield 2 as 5 year MACRS.)

Explanation / Answer

tax in first shield is on $530,000

40% on $530,000 is = $212,000

second shield = total value is $530,000 + $63000= $593,000

depreciation on that is $63,000, it should be deduct = $593,000 - $63,000

= $530,000

40% tax on $530,000 = $212,000

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