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 $480,000. Of this sum, $58,000 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 expense or as a capital investment. In the latter case, the company could depreciate the $58,000 using the five-year MACRS tax depreciation schedule. Assume the tax rate is 35% 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.) (Do not round intermediate calculations. Round your answers to the nearest dollar amount.)

Tax shield 1 $

Tax shield 2 $

Explanation / Answer

Tax Shield -1- An Expense Treatment

Tax Shiled= $65,000*34%

= 22,100

NPV of 22,1000= 22,100*0.9524

= 21,048

Tax Shield-2 -5 Years MACRS

IF Expense treatement is considered (Tax Shield-1) tax shield will be $21,048

If Capital treatment is considered (Tax Shiled-2) tax shield will be $19,136

Year Depreciation Amount Tax Shield% Tax Shield amount PV Factor NPV of Tax Shield 1 13,000 34% 4,420 0.9524 4209.61 2 13,000 34% 4,420 0.9070 4008.94 3 13,000 34% 4,420 0.8638 3818 4 13,000 34% 4,420 0.8227 3636.33 5 13,000 34% 4,420 0.7835 3463.07 Total 19,136

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