Question

Rush Corporation plans to acquire production equipment for $612,500 that will be depreciated for tax purposes as follows: year 1, $122,500; year 2, $212,500; and in each of years 3 through 5, $92,500 per year. A 14 percent discount rate is appropriate for this asset, and the company’s tax rate is 40 percent. Use Exhibit A.8 and Exhibit A.9. Required: a. Compute the present value of the tax shield resulting from depreciation. (Round PV factor to 3 decimal places and other intermediate calculations to nearest whole number.) b. Compute the present value of the tax shield from depreciation assuming straight-line depreciation ($122,500 per year). (Round PV factor to 3 decimal places and other intermediate calculations to nearest whole number.)

Answer 1

Part a
Calculation of present value of tax shielding resulting from depreciation
Year	Dep.	Tax @ 40%	Tax Shielding	P.V. Factor @14%	Present Value
1	$        122,500	$        49,000	$     73,500	0.877	$        64,460
2	$        212,500	$        85,000	$   127,500	0.769	$        98,048
3	$          92,500	$        37,000	$     55,500	0.675	$        37,463
4	$          92,500	$        37,000	$     55,500	0.592	$        32,856
5	$          92,500	$        37,000	$     55,500	0.519	$        28,805
Total	$        612,500	$     245,000	$   367,500		$     261,630
Part b
If Depreciation is calculated using straight line method
Depreciation = 612500 /5 = $122500
Year	Dep.	Tax @ 40%	Tax Shielding	P.V. Factor @14%	Present Value
1	$        122,500	$        49,000	$     73,500	0.877	$        64,460
2	$        122,500	$        49,000	$     73,500	0.769	$        56,522
3	$        122,500	$        49,000	$     73,500	0.675	$        49,613
4	$        122,500	$        49,000	$     73,500	0.592	$        43,512
5	$        122,500	$        49,000	$     73,500	0.519	$        38,147
Total	$        612,500	$     245,000	$   367,500		$     252,252