Question

Suppose a firm has just made an investment in France that will generate $2 million annually in depreciation, converted at today's spot rate. Projected annual rates of inflation in France and in the United States are 7 percent and 4 percent, respectively. If the real exchange rate is expected to remain constant and the French tax rate is 50 percent, what is the expected real value (in terms of today's dollars) of the depreciation charge in year 5, assuming that the tax write‑off is taken at the end of the year?

Answer 1

If the French tax rate is 50%, then a depreciation charge of $2 million is worth $1 million in today's dollars

real dollar value of the depreciation tax write‑off will decline at the rate of 7% p.a

Real value in year 5, If the real dollar value of this write‑ off is declining at the rate of 7% annually, given that the write‑off is taken at the end of the year

= $1,000,000/(1.07)^5 = $712,986.00