The additional depreciation tax shield would be $3,600.
Before the new project, the old equipment has a carrying value of $12,000 (historical cost 220k - accumulated depreciation 208k = 12k). It has a remaining useful life of 2 years and on a straight-line depreciation basis, would be depreciated $6,000/year. At a 40% tax rate, this gives a depreciation tax shield of 6000*0.40 = $2,400.
The new equipment has an initial cost of $160,000 and an expected salvage value of $10,000 so the total amount you can depreciate is $150,000. Straight-line depreciation over a 10 year useful life would be $15,000 annual depreciation. At a 40% tax rate, this gives a depreciation tax shield of $6,000.
You would sell the old equipment, so you won't get that deprecation tax shield. Instead of a depreciation tax shield of $2,400, you'd only have a depreciation tax shield of $6,000. If you take the new amount $6,000 less the old amount $2,400, you have an additional depreciation tax shield of $3,600.
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Michelle Burke
Student
Plaistow NH
United States
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Original Message:
Sent: 02-12-2021 05:29 PM
From: Nupur Mahajan
Subject: Depreciation Tax Shield
The company would have to commit $24,000 of working capital in addition to an immediate outlay of $160,000 for new equipment. The project is expected to generate $100,000 of annual income for 10 years. At the end of that time, the new equipment, which will be depreciated on a straight-line basis, is expected to have a salvage value of $10,000.
The existing equipment that would be sold to make room for the project has a historical cost of $220,000 and accumulated depreciation of $208,000. It has an estimated remaining useful life of 2 years and the remaining carrying amount is being depreciated on a straight-line basis. A scrap dealer has agreed to buy it for $8,000.
The company's effective tax rate is 40%.
What is the expected additional depreciation tax shield for the first year of the project is?
A. $6,400 B. $4,000 C. $2,400 D. $0
I am confused - I know the dep tax shield of the new Machine for year one is 6400 and the old machine for year one is 2400. But what is the meaning of "Additional dep tax shield"? The correct answer is 4000. Can anyone explain how?
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Nupur Mahajan
None
Hartford CT
United States
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