Question

ABC Skilled Nursing Center, an investor-owned company, constructed a new building to replace its outdated facility. The new building was completed on January 1, 2018, ABC Nursing Center began recording depreciation immediately. The total cost of the new facility was $20,000,000, comprising (a) $18,000,000 in construction cost and (b) $2,000,000 for the land. ABC Skilled Nursing Center estimated that the new facility would have a useful life of 20 years. The salvage value of the building at the end of its useful life was estimated to be $1,000,000

a. Using the straight-line method of depreciation, calculate annual depreciation expense on the new facility.

b. Assume a 30 percent income tax rate, how much did ABC Skilled Nursing Center save in income taxes for the year ended December 31, 2018, as a result of the depreciation recorded on the new facility (what was the depreciation shield)?

c. Does the depreciation shield result in cash or noncash savings for ABC Skilled Nursing Center? Explain.

Answer 1

a) Land 2000000 Non depreciable

Construction cost 18000000 Depreciable

Total 20000000

Salvage value 1000000

Time 20 years

Annual depreciation charge 850000 (18000000-1000000)/20

b) Tax savings 255000 30%*850000

c) Depreciation shield results in lesser net cash outflow due to lower taxes

Hence it is a cash savings