Question

Your Company is considering a new project that will require $870,000 of new equipment at the start of the project. The equipment will have a depreciable life of 7 years and will be depreciated to a book value of $65,000 using straight-line depreciation. The cost of capital is 12%, and the firm's tax rate is 40%. Estimate the present value of the tax benefits from depreciation.

a. $46,000

b. $115,000

c. $209,933

d. $69,000

Answer 1

Ans:- Depreciation by a straight line is given by ( Value of assets - Salvage Value ) / Useful life

=( $870,000 - $65,000 ) / 7 = $115,000

Now the annual benefit will be Annual depreciation * Tax rate = $115,000 * 0.40 = $46,000

That means $46,000 is saved each year for 7 years. we will use the PV function of excel to find the Present Value of the tax benefits from depreciation.

Therefore, the Present Value of the tax benefits from depreciation is $209,932.80 i.e $209,933 (approx). option (c) is the right answer.

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