Question

4. Under the new tax law, firms will be allowed to fully expense new capital expenditures. That is, instead of depreciating new fixed assets, firms may recognize the cost paid for new fixed assets as a tax-deductible expense at the time of the purchase of the new asset. The new tax law will also change the corporate tax rate to 21%.. You are considering the purchase of a new machine. The total cost of the new machine is $1,000,000 and will be paid today. Under the old tax system, your firm depreciates new fixed assets. The firm uses straight-line depreciation (assuming a five-year life and no salvage value). The first year of depreciation expense is recognized at the end of the first year of the fixed asset's five-year life. The firm expects to be profitable throughout the foreseeable future. Under the prior tax law, the firm's corporate tax rate was 32%. Also, the firm's required return is 18%, and its bonds are rated BB.. Provide calculations to show whether the new tax law will make the investment in the new machine more or less likely. Calculations should be as specific as possible..

Answer 1

Given

Cost of new machine = $1000000

Old corporate tax rate = 32%

New Corporate Tax Rate = 21%

Calculation of saving due to change in tax rate

Total Tax savings in old corporate tax structure

Year	Depreciation	Tax	PV factor @ 18%	Present value
1	200000	64000	0.85	54237
2	200000	64000	0.72	45964
3	200000	64000	0.61	38952
4	200000	64000	0.52	33010
5	200000	64000	0.44	27975
			Total	200139

Tax Saving under New Corporate tax structure

$1000000 * 21% = $2,10,000

Hence New Tax Law will make the investment in new machine profitable by $9,861