Question

In: Finance

Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just ordered...

Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just ordered a new kiln for $420,000. Of this sum, $52,000 is described by the supplier as an installation cost. Ms. Potts does not know whether the Internal Revenue Service (IRS) will permit the company to treat this cost as a tax-deductible current expense or as a capital investment. In the latter case, the company could depreciate the $52,000 using the five-year MACRS tax depreciation schedule.

Assume the tax rate is 30% and the opportunity cost of capital is 7%. Calculate the value of the tax shield if the kiln is currently expensed and if it is treated as a capital investment. (Do not round intermediate calculations. Round your answers to the nearest whole dollar amount.)

Tax shield if currently expensed $
Tax shield if capital investment $

Solutions

Expert Solution

Calculation of Persent Value of Tax shield if currently expensed
Present Value of Tax shield if currently expensed = Total Installation cost x Tax rate x Discount factor @ 7% for Year 1
Present Value of Tax shield if currently expensed = $52000 x 30% x (1+0.07)^-1
Present Value of Tax shield if currently expensed = $15,600 x 0.93458
Present Value of Tax shield if currently expensed = $14,579
Calculation of Present Value of Tax shield if capital investment
Year Installation Cost Depreciation rate (5 Year MACRS) Depreciation Tax Rate Tax Shield Discount Factor @ 7% Present Value of Tax shield
A B C D = B x C E F=D x E G F x G
1 $52,000.00 20% $10,400.00 30% $3,120.00 0.93458 $2,915.89
2 $52,000.00 32% $16,640.00 30% $4,992.00 0.87344 $4,360.21
3 $52,000.00 19.20% $9,984.00 30% $2,995.20 0.81630 $2,444.98
4 $52,000.00 11.52% $5,990.40 30% $1,797.12 0.76290 $1,371.01
5 $52,000.00 11.52% $5,990.40 30% $1,797.12 0.71299 $1,281.32
6 $52,000.00 5.76% $2,995.20 30% $898.56 0.66634 $598.75
Present Value of Tax shield if capital investment $12,972
Tax shield if currently expensed $14,579
Tax shield if capital investment $12,972

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