Question

Your company is considering a new project that will require $100,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $25,000 using straight-line depreciation. The cost of capital is 11 percent, and the firm's tax rate is 34 percent. Estimate the present value of the tax benefits from depreciation.

Answer 1

We need to calculate the present value of the tax benefits over 10 year period for the firm.

As this is straight line depreciation the amount depreciated every year will be 7,500

Depreciation value = Cost of the project - salvage value / no of years.

= (100000 - 25000) / 10

= 75000/ 10 = 7500

As the depreciation allowed per year is 7,500 we will save 34% of the depreciation amount which we would have paid in taxes if we had not taken up this project.

34% of 7500 = 2550

Present Value of all the tax saved at 11% per annum for a period of 10 years is as follows:

We will use the PV formula in excel.

Particulars	Amount
Future Value	0
Tax saving per year	2550
No of years	10
Interest rate	11%
Present Value of the tax saved	-15,017.54

The present value of the tax saved is 15,017.54