Your company is considering a new project that will require $10,000 of new equipment at the start of the project. The equipment will have a depreciable life of five years and will be depreciated to a book value of $3,000 using straight-line depreciation. The cost of capital is 9 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation.
A) $476
B) $924
C) $5,446
D) $1,143.56

Question

Quizplus · Accepted Answer

The present value of the tax benefits from depreciation can be calculated using the depreciation expense, the firm's tax rate, and the cost of capital. The annual depreciation expense is ($10,000 - $3,000) / 5 = $1,400. The annual tax shield is $1,400 * 21% = $294. The present value of this annual tax shield over 5 years at a 9% discount rate can be calculated using the formula for the present value of an annuity: PV = P * [(1 - (1 + r)^-n) / r], where P is the annual payment ($294), r is the discount rate (9% or 0.09), and n is the number of periods (5 years). Plugging in the numbers gives PV = $294 * [(1 - (1 + 0.09)^-5) / 0.09] ≈ $1,143.56.

Your Company Is Considering a New Project That Will Require