Question

3.8 Bright Horizons Skilled Nursing Facility, an investor-owned company, constructed a new building to replace its outdated facility. The new building was completed on January 1, 2015, and Bright Horizons began recording depreciation immediately. The total cost of the new facility was $18,000,000, comprising (a) $10 million in construction costs and (b) $8 million for the land. Bright Horizons estimated that the new facility would have a useful life of 20 years. The salvage value of the building at the end of its useful life was estimated to be $1,500,000.

Using the straight-line method of depreciation, calculate annual depreciation expense on the new facility

Assuming a 40 percent income tax rate, how much did Bright Horizons save in income taxes for the year ended December 31, 2015, as a result of the depreciation recorded on the new facility (i.e., what was the depreciation shield)?

Does the depreciation shield result in cash or noncash savings for Bright Horizons? Explain.

Answer 1

Land is not depreciable, only buidling is depreciated:

	Straight line method:
	Depreciatin expense=	[Cost- salvage value]/ useful life
	Cost=	1,00,00,000
	Salvage value=	15,00,000
	Useful life (in years)=	20
a	Depreciatin expense=	[10000000-1500000]/ 20
		4,25,000 Per year

Tax shield= 425000*40% =170000

Tax shield results in cash savings for bright horizon, because tax shield reduces tax payable by that amount hence it is cash savings in the form of reduced income tax payable. without tax shield company should have paid 170000 in income taxes extra.