Question

Your Company is considering a new project that will require $20,000 of new equipment at the start of the project. The equipment will have a depreciable life of 5 years and will be depreciated to a book value of $7,000 using straight-line depreciation. The cost of capital is 9%, and the firm's tax rate is 34%. Estimate the present value of the tax benefits from depreciation.

Answer 1

Step-1:Calculate depreciation expenses
Depreciartion expense as per Straight Line Method					=	(Cost-salvage value)/Useful Life
					=	(20000-7000)/5
					=	$     2,600
Step-2:Calculate tax benefit from depreciation
Tax Beneffit from depreciation			=	Depreciation exppenses x tax Rate
			=	$     2,600	x 34%
			=	$       884
Step-3:Calculate present value of tax savings
Present Value of tax benfits			=	Annual Tax x Present value of annuity of $1 at 9%
			=	$       884	x	3.8897
			=	$     3,438
Working:
Present value of annuity of $ 1			=	(1-(1+i)^-n)/i		Where,
			=	(1-(1+0.09)^-5)/0.09		i	9%
			=	3.8897		n	5
Thus, present value of the tax benefits from depreciation is					$   3,438