Question

Your company is considering a new project that will require $10,000 of new equipment at the start of the project. The equipment will have a depreciable life of five years and will be depreciated to a book value of $3,000 using straight-line depreciation. The cost of capital is 9 percent, and the firm's tax rate is 34 percent. Estimate the present value of the tax benefits from depreciation.

Answer 1

Present value of the tax benefits from depreciation.

year	Depreciation	Tax benefit from depreciation(depreciation *tax rate)	Present value factor @ 9%	Present value
I	II	III	IV	V=III*IV
1	3000	3000*34% = 1020	0.9174	935.7480
2	3000	3000*34% = 1020	0.8417	858.5340
3	3000	3000*34% = 1020	0.7722	787.6440
4	3000	3000*34% = 1020	0.7084	722.5680
5	3000	3000*34% = 1020	0.6499	662.8980
Total Present value of the tax benefits from depreciation				3967.3920

Calculation of Discounting Factor

Discount Factor = 1/ (1+R) ^N

R = Discount Rate (i.e. = 9%)

N = No of years

E.g. for year 2 Discount Factor = 1/ (1.09)²

                                                                ⁼ 1/ (1.09) (1.09)

                                                = 0.8417

NOTE

Depreciation = 3000 per year

tax rate = 34%

cost of capital = 9%