Question

Depreciation Tax Shields
Mendota Company has purchased equipment for $200,000. After it is fully depreciated, the equipment will have no salvage value. Mendota may select either of the following depreciation schedules for tax purposes:

	Option 1	Option 2
Year	Depreciation	Depreciation
1	$40,000	$20,000
2	64,000	40,000
3	38,400	40,000
4	23,040	40,000
5	23,040	40,000
6	11,520	20,000

Assuming a 40% tax rate and a 12% desired annual return, compute the total present value of the tax savings provided by these alternative depreciation tax shields.
Round answers to the nearest whole number. Use rounded answers to calculate total.

Option 1 depreciation:

Year (N)	Tax Savings (FV)	Present Value
1	$Answer	$Answer
2	Answer	Answer
3	Answer	Answer
4	Answer	Answer
5	Answer	Answer
6	Answer	Answer
		$Answer

Option 2 depreciation:

Year (N)	Tax Savings (FV)	Present Value
1	$Answer	$Answer
2	Answer	Answer
3	Answer	Answer
4	Answer	Answer
5	Answer	Answer
6	Answer	Answer
		$Answer

Which depreciation schedule would be more attractive to Mendota?

Answer

Answer 1

Option 1 :
Year (N)	Depreciation	Tax Savings (FV)	PVIF at 12%	Present Value of tax savings
1	40000	16000	0.89286	$       14,285.71
2	64000	25600	0.79719	$       20,408.16
3	38400	15360	0.71178	$       10,932.94
4	23040	9216	0.63552	$        5,856.93
5	23040	9216	0.56743	$        5,229.41
6	11520	4608	0.50663	$        2,334.56
Total	200000	80000		$       59,047.72
Option 2:
Year (N)	Depreciation	Tax Savings (FV)	PVIF at 12%	Present Value of tax savings
1	20000	8000	0.89286	$        7,142.86
2	40000	16000	0.79719	$       12,755.10
3	40000	16000	0.71178	$       11,388.48
4	40000	16000	0.63552	$       10,168.29
5	40000	16000	0.56743	$        9,078.83
6	20000	8000	0.50663	$        4,053.05
Total	200000	80000		$       54,586.61
ANSWER:
DEPRECIATION SCHEDULE UNDER OPTION 1 WOULD BE MORE ATTRACTIVE AS
THE PV OF THE TAX SHIELDS IS HIGHER.