Your firm is considering a project that would require purchasing $7.1 million wo

Question

Your firm is considering a project that would require purchasing $7.1 million worth of new equipment. Determine the present value of the depreciation tax shield associated with this equipment if the firm's tax rate is 36%, the appropriate cost of capital is 9%, and the equipment can be depreciated:

a. Straight-line over a ten-year period, with the first deduction starting in one year.

The present value of the depreciation tax shield associated with this equipment is ?million.

b. Straight-line over a five-year period, with the first deduction starting in one year.

The present value of the depreciation tax shield associated with this equipment is ?million.

c. Using MACRS depreciation with a five-year recovery period and starting immediately.

The present value of the depreciation tax shield associated with this equipment is ?million.

d. Fully as an immediate deduction.

The present value of the depreciation tax shield is ? million

Explanation / Answer

d. If dipreciation is charged fully tahn depreciation will be $7100000 and Tax shield will be 36% of $7100000 = $2556000.

Present value of Tax shield would be $2556000.

Value of Asset $7,100,000 Tax rate 36% Cost of Capital 9% a. Calculation of NPV of tax shield on depreciation by using straight line depreciation method for 10 Years Straight line depreciation per year = $7100000/10 = $710000 Years Value of asset Depreciation Tax shield Present value of tax shield 1 $7,100,000 $710,000 $255,600 $107,968.20 2 $7,100,000 $710,000 $255,600 $107,968.20 3 $7,100,000 $710,000 $255,600 $107,968.20 4 $7,100,000 $710,000 $255,600 $107,968.20 5 $7,100,000 $710,000 $255,600 $107,968.20 6 $7,100,000 $710,000 $255,600 $107,968.20 7 $7,100,000 $710,000 $255,600 $107,968.20 8 $7,100,000 $710,000 $255,600 $107,968.20 9 $7,100,000 $710,000 $255,600 $107,968.20 10 $7,100,000 $710,000 $255,600 $107,968.20 NPV $1,079,682.02

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