Question

Your Company is considering a new project that will require $620,000 of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $100,000 using straight-line depreciation. The cost of capital is 11%, and the firm's tax rate is 21%. Estimate the present value of the tax benefits from depreciation.

• $10,920

• $64,310

• $41,080

• $52,000

Answer 1

$64,310

Step-1:Calculation of annual depreciation
Straight line depreciation	=	(Cost - Salvage value)/Useful Life
	=	(620000-100000)/10
	=	$       52,000
Step-2:Calculation of tax benefit from depreciation
Tax benefit	=	Annual depreciation	*	Tax rate
	=	$       52,000	*	21%
	=	$       10,920
Step-3:Calculation of present value of tax benefits
Present value of tax benefit	=	Annual tax benefit	*	Present value of annuity of 1
	=	$       10,920	*	5.889232
	=	$       64,310
Working:
Present value of annuity of 1	=	(1-(1+i)^-n)/i		Where,
	=	(1-(1+0.11)^-10)/0.11		i	=	11%
	=	5.88923201		n	=	10