Question

Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just ordered a new kiln for $450,000. Of this sum, $55,000 is described by the supplier as an installation cost. Ms. Potts does not know whether the Internal Revenue Service (IRS) will permit the company to treat this cost as a tax-deductible current expense or as a capital investment. In the latter case, the company could depreciate the $55,000 using the five-year MACRS tax depreciation schedule Assume the tax rate is 40% and the opportunity cost o capital is 5%. Cal late the value of the x shield round intermediate calculations. Round your answers to the nearest whole dollar amount.) the n is current expensed and t s reated as a cap al nvestment on t Tax shield if currently expensed Tax shield if capital investment References eBook & Resources Worksheet Difficulty: Intermediate

Answer 1

Tax shield if installation cost is currently expensed = tax*installation cost = 40%*55,000 = 22,000

Tax shield if treated as a capital investment:

Year (n)	Depreciation %age	Depreciation expense (D)	Cumulated dep.	Book Value	Tax shield (TS) (D*40%)	Discount factor 1/(1+5%)^n	PV of tax shield (TS*discount factor)
0				55,000.00
1	20%	11,000.00	11,000.00	44,000.00	4,400.00	0.952	4,190.48
2	32%	17,600.00	28,600.00	26,400.00	7,040.00	0.907	6,385.49
3	19.20%	10,560.00	39,160.00	15,840.00	4,224.00	0.864	3,648.85
4	11.52%	6,336.00	45,496.00	9,504.00	2,534.40	0.823	2,085.06
5	11.52%	6,336.00	51,832.00	3,168.00	2,534.40	0.784	1,985.77
6	5.76%	3,168.00	55,000.00	-	1,267.20	0.746	945.60
							19,241.24

Tax shield if treated as a capital investment = 19,242