Question

The Lumber Yard is considering adding a new product line that is expected to increase annual sales by $347,000 and expenses by $240,000. The project will require $149,000 in fixed assets that will be depreciated using the straight-line method to a zero book value over the 8-year life of the project. The company has a marginal tax rate of 40 percent. What is the depreciation tax shield?

Answer 1

Given

Cost of Fixed asset = $149,000
Life of project = 8 years
Tax rate = 40%

Step 1 : Calculation of Depreciation

Particulars	Amount
Cost of Fixed asset	$149,000.00
Less: Salvage value	Nil
Depreciable value ...(A)	$149,000.00
Life of project ...(B)	8 years
Depreciation as per SLM (A)/(B)	$18,625.00

Depreciation remains same over the period of time under SLM method

Step 2 : Calculation of Depreciation tax shield

Depreciation tax shield (DTS) = Depreciation Expense * Tax rate

Depreciation tax shield (DTS) = $18,625 * 40%

Depreciation tax shield (DTS) = $7,450

Assuming that there will be no change tn the marginal tax rates in future. The depreciation tax shield shall remain be $7450 for the every year of the life of the project.