Question

Rush Corporation plans to acquire production equipment for $642,500 that will be depreciated for tax purposes as follows: year 1, $128,500; year 2, $218,500; and in each of years 3 through 5, $98,500 per year. An 8 percent discount rate is appropriate for this asset, and the company’s tax rate is 40 percent. Use Exhibit A.8 and Exhibit A.9.

Required:

a. Compute the present value of the tax shield resulting from depreciation. (Round PV factor to 3 decimal places and other intermediate calculations to nearest whole number.)

b. Compute the present value of the tax shield from depreciation assuming straight-line depreciation ($128,500 per year). (Round PV factor to 3 decimal places and other intermediate calculations to nearest whole number.)

Answer 1

Solution a:

Computation of Present value of tax shield resulting from depreciation
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Depreciation for tax purpose	$128,500.00	$218,500.00	$98,500.00	$98,500.00	$98,500.00
Tax rate	40%	40%	40%	40%	40%
Tax shield	$51,400.00	$87,400.00	$39,400.00	$39,400.00	$39,400.00
PV Factor (8%)	0.926	0.857	0.794	0.735	0.681
Present value of tax shield	$47,596	$74,902	$31,284	$28,959	$26,831	$209,572

Solution b:

Computation of Present value of tax shield resulting from depreciation
Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Depreciation for tax purpose	$128,500.00	$128,500.00	$128,500.00	$128,500.00	$128,500.00
Tax rate	40%	40%	40%	40%	40%
Tax shield	$51,400.00	$51,400.00	$51,400.00	$51,400.00	$51,400.00
PV Factor (8%)	0.926	0.857	0.794	0.735	0.681
Present value of tax shield	$47,596	$44,050	$40,812	$37,779	$35,003	$205,240