Question

Problem 6-18 Depreciation and project NPV Suppose that Sudbury Mechanical Drifters is proposing to invest $11.4 million in a new factory. It can depreciate this investment straight-line over 10 years. The tax rate is 35%, and the discount rate is 10% a. What is the present value of Sudbury's depreciation tax shields? (Enter your answers in millions rounded to 1 decimal place.) Stralahteline Schedule Year Year Straight-line, 10-year Tax Shields at 35% TC PV (Tax Shields) at $ 1.1 $ 1. 1 $ 0.40$ 0. 4 $ 0.40 $ 0.3 X Answer is complete but not entirely correct. Year Year Year Year Year Year Year Year 7 8 fear 9 Year 10 Total 5 1.10 $ 1. 1 5 1. 1 1.1 $ 1. 1 5 1.1 1.1 $ 1. 1 5 11.4 5 0. 45 0.40 $ 0.405 040$ 0. 43 0.405 40$ 0.404.00 0.30 $ 0.3 $ 0.20 0.20 0.20 0.20 02 $ 0.20 $ 2.5 b. Suppose that the government allows companies to use double-declining-balance depreciation with the option to switch at any point to straight-line. Now what is the present value of the depreciation tax shields? (Enter your answers in millions rounded to 1 decimal place.) Double decline Schedule Start of Year Book Value Depreciation Tax Shields at 35% TC PV (Tax Shields) at 10% * Answer is complete but not entirely correct. ear Year Year Year Year Yar Yar Yar Yar Yar Year Year Year Year Year Year Total 7 8 9 10 Total $11.40 $ 9.10 $ 7.30 S 5.8 $ 4.70 $ 3.70 $ 3.00 $ 24% $ 1.39 S 1.5% 5 50.8% $ 23 $ 1.8 $ 1.50 $ 1.2 $0. $ 0.7 0 05 $ 0.4% $ 0.3% $ 10.2% $ 0.8 $ 0.6 0.50 $ 0.40 $ 0.3 $ 03 $ 02 $ 02 $ 0.1 $ 0.1 $ 3.6% $ 0. 7 8 0.50 $ 0.4 $ 03 $ 0. 2 8 0. 1 0. 1 0. 1 8 0.10 $0.00 $ 25% c. What would be the present value of the tax shield if the government allowed Sudbury to write-off the factory immediately? (Enter your answer in millions rounded to 1 decimal place.) Answer is complete and correct. Percent value of depreciation tax shields $ 4.00

Answer 1

A-
Year	1	2	3	4	5	6	7	8	9	10
Straight line depreciation = cost of equipment/life of equipment = 11.4/10	1.1	1.1	1.1	1.1	1.1	1.1	1.1	1.1	1.1	1.1
Tax Shield-35% of straight line depreciation = 1.1*35%	0.4	0.4	0.4	0.4	0.4	0.4	0.4	0.4	0.4	0.4
present value factor at 10% = 1/(1+r)^n r =10% n= 1,2,3,……………10	0.909091	0.826446	0.751315	0.683013	0.620921	0.564474	0.513158	0.4665074	0.424097618	0.385543
present value of tax shield = tax shield*present value factor	0.4	0.3	0.3	0.3	0.2	0.2	0.2	0.2	0.2	0.2
B-
rate of straight line depreciation	1/life of equipment	1/10	10%
double declining rate	straight line rate*2	10*2	20%
Year	beginning balance	double declining rate	annual depreciation = beginning balance*double declining rate	year end balance
1	11.4	20%	2.28	9.12
2	9.12	20%	1.824	7.296
3	7.296	20%	1.4592	5.8368
4	5.8368	20%	1.16736	4.66944
5	4.66944	20%	0.933888	3.735552
6	3.735552	20%	0.74711	2.988442
7	2.988442	20%	0.597688	2.390753
8	2.390753	20%	0.478151	1.912603
9	1.912603	20%	0.382521	1.530082
10	1.530082	20%	0.306016	1.224066
Year	1	2	3	4	5	6	7	8	9	10
start of the year book value	11.4	9.1	7.3	5.8	4.7	3.7	3.0	2.4	1.9	1.5
Annual Depreciation using -double declining depreciation method	2.3	1.8	1.5	1.2	0.9	0.7	0.6	0.5	0.4	0.3
Tax Shield-35% of annual depreciation = annual depreciation*35%	0.8	0.6	0.5	0.4	0.3	0.3	0.2	0.2	0.1	0.1
present value factor at 10% = 1/(1+r)^n r =10% n= 1,2,3,……………10	0.909091	0.826446	0.751315	0.683013	0.620921	0.564474	0.513158	0.4665074	0.424097618	0.385543
present value of tax shield = tax shield*present value factor	0.7	0.5	0.4	0.3	0.2	0.1	0.1	0.1	0.1	0.0