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A firm invests $10 million in a new stamping machine. It depreciates it straight line for...

A firm invests $10 million in a new stamping machine. It depreciates it straight line for tax purposes over 5 years. The tax rate is 30%, inflation is 4% a year, and the discount rate is 8%. What is the PV of the depreciation tax shield?

Multiple Choice

  • $600,000.

  • $2,395,626.

  • $2,579,497.

  • $3,000,000.

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Answer #1

Answer: Option-(b): $2,395,626 Reason: Annual discount rate, RATE Number of years of tax shield, NPER Annual depreciation tax shield, PMT Lumpsum receipt at the end, FV Annual cash flow type, TYPE PV of depreciation tax shield 896 yearly pv $600,000 [($10,000,000 / 5 years) x 30%) $o 00 if tax shield recd. at the end of of each year; 1 tax shield recd. at the beginning of each year $2,395,626.02 [Ref: NOTE] NOTE: As the annual depreciation expense is not affected by inflation rate, due to its nature of amortization of historical cost of the asset, inflation rate is not considered in the present value calculation.Present Value of given cash flows is calculated using EXCEL FUNCTION PV(rate,nper,pmt,fv,type) where rate-8%; nper-5; pmt-600000; fv:0; type-o Here, value for pmt is negative as it denotes cash inflows; type 0 because cash flows occur at the end of each year only. C. 1 Annual discount rate, RATE 2 Number of years of tax shield, NPER 3 Annual depreciation tax shield, PMT- 10000000/5)*30% 4 Lumpsum receipt at the end, FV 5 Annual cash flow type, TYPE 6 PV of depreciation tax shield 8% ($10,000,000 /5years) x 30%) $o 0 0 if tax shield recd. at the end of of each year; 1 tax shield recd. at the beginning of each year PV(B1,B2,-B3,B4,B5) [Ref: NOTE]

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