Sway's Market is considering a project that will require the purchase of $1.4 million in new equipment. The equipment will be depreciated straight-line to zero over the 5-year life of the project. The firm expects to sell the equipment at the end of the project for 20 percent of its original cost. New net working capital equal to 10 percent of sales will be required to support the project. All of the new net working capital will be recouped at the end of the project. Annual sales are estimated at $750,000 with costs of $338,000. The required rate of return is 12 percent and the tax rate is 34 percent. What is the value of the depreciation tax shield in Year 2 of the project?

Question

Business

Paris Mcknight

6 June, 17:50

Sway's Market is considering a project that will require the purchase of $1.4 million in new equipment. The equipment will be depreciated straight-line to zero over the 5-year life of the project. The firm expects to sell the equipment at the end of the project for 20 percent of its original cost. New net working capital equal to 10 percent of sales will be required to support the project. All of the new net working capital will be recouped at the end of the project. Annual sales are estimated at $750,000 with costs of $338,000. The required rate of return is 12 percent and the tax rate is 34 percent. What is the value of the depreciation tax shield in Year 2 of the project?

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Answers (1)

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Amir Heath · Answer 1

tax shield year 2 95,200

Explanation:

The tax shield will be the depreciation expense times tax rate

Our first step is to calculate the depreciation expense:

The equipment is worth 1.4 million and has a 5-years useful life

It is being depreciate on straight-line

depreciation per year

equipment / useful life

1.4 million / 5 = 0.28 = 280,000

Now we apply the tax rate of 34%

280,000 x 34% = 95,200

This will be the tax shield on Year 2