Your company is considering a new project that will require $250,000 of new equipment at the start of the project. The equipment will have a depreciable life of eight years and will be depreciated to a book value of $10,000 using straight-line depreciation. The cost of capital is 12 percent, and the firm's tax rate is 21 percent. Estimate the present value of the tax benefits from depreciation.
A) $63,618
B) $31,296
C) $117,733
D) $86,997

Question

Quizplus · Accepted Answer

The present value of the tax benefits from depreciation can be calculated by finding the annual depreciation expense, then determining the tax shield from depreciation, and finally discounting these tax shields back to their present value using the cost of capital. Annual depreciation expense = (Initial cost - Salvage value) / Useful life = ($250,000 - $10,000) / 8 = $30,000.Tax shield per year = Depreciation expense * Tax rate = $30,000 * 21% = $6,300.Present value of tax shield = Tax shield per year * Present value annuity factor. The present value annuity factor for 8 years at 12% = 4.968. So, the present value of the tax shield = $6,300 * 4.968 ≈ $31,296.

Your Company Is Considering a New Project That Will Require