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Rush Corporation plans to acquire production equipment for $622,500 that will be depreciated for tax purposes...

Rush Corporation plans to acquire production equipment for $622,500 that will be depreciated for tax purposes as follows: year 1, $124,500; year 2, $214,500; and in each of years 3 through 5, $94,500 per year. A 12 percent discount rate is appropriate for this asset, and the company’s tax rate is 40 percent. Use Exhibit A.8 and Exhibit A.9.

Required:

a. Compute the present value of the tax shield resulting from depreciation.

b. Compute the present value of the tax shield from depreciation assuming straight-line depreciation ($124,500 per year).

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Answer #1

(a)

Year Depreciation ($) Tax rate Tax shield ($) PV factor @ 12% Present value ($)

1

2

3

4

5

124500

214500

94500

94500

94500

40%

40%

40%

40%

40%

49800

85800

37800

37800

37800

0.893

0.797

0.712

0.636

0.567

44466

68400

26906

24022

21448
185242

(b)

tax shield per annum = $124500 x 40% = $49800

present value = tax shield per annum x PVAF(12%, 5)

= $49800 x 3.605

= $179529

where,

PVAF(12%, 5) = 3.605

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