Question

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	$

Answer 1

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