Question

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 34 percent. Estimate the present value of the tax benefits from depreciation.
A. $476
B. $924
C. $1,400
D. $1,851

Answer 1

Answer:

Estimate the present value of the tax benefits from depreciation:

D. $1,851

Explanation:

Step 1: Determine annual depreciation

A.D=(A.C-S.V)/N

where;

A.D=annual depreciation

A.C=acquisition cost

S.V=salvage value

N=useful life

In our case;

A.D=unknown, to be determined

A.C=$10,000

S.V=$3,000

N=5 years

replacing;

A.D={(10,000-3,000)/5}=7,000/5=$1,400

Annual depreciation=$1,400

Step 2: Determine annual tax benefits

Annual tax benefits=tax rate×annual depreciation

where;

tax rate=34%=34/100=0.34

annual depreciation=$1,400

replacing;

Annual tax benefits=0.34×1,400=$476

Step 3: Determine present value of the annual tax benefits

Year                  Future value                Present value

 1                          476                            476/{(1+0.09)^1}=436.70

 2                         476                            476/{(1+0.09)^2}=400.64

 3                         476                            476/{(1+0.09)^3}=367.56

 4                         476                            476/{(1+0.09)^4}=337.21

 5                         476                            476/{(1+0.09)^5}=309.37

Total present value of the tax benefits=436.70+400.64+367.56+337.21+309.37=$1,851.48

Estimate the present value of the tax benefits from depreciation=$1,851