Question

Markov Manufacturing recently spent $14.4 million to purchase some equipment used in the manufacture of disk drives. The firm expects that this equipment will have a useful life of five years, and its marginal corporate tax rate is 21%. The company plans to use straight-line depreciation.

a. What is the annual depreciation expense associated with this equipment?

b. What is the annual depreciation tax shield?

c. Rather than straight-line depreciation, suppose Markov will use the MACRS depreciation method for the five-year life of the property. Calculate the depreciation tax shield each year for this equipment under this accelerated depreciation schedule. The depreciation tax shield for year 1 is ______ million.

d. If Markov has a choice between straight-line and MACRS depreciation schedules, and its marginal corporate tax rate is expected to remain constant, which schedule should it choose? Why?

e. How might your answer to part (d.) change if Markov anticipates that its marginal corporate tax rate will increase substantially over the next five years?

f. Under the TCJA of 2017, Markov has the option to take 100% "Bonus" depreciation in the year in which the equipment is put into use. This means that in that year, Markov would take the full depreciation expense equivalent to the cost of buying the equipment. Rather than straight-line depreciation, suppose Markov will use the bonus depreciation method. Calculate the depreciation tax shield each year for this equipment with bonus depreciation.

Answer 1

Under straight-line method, Annual depreciation expense (Cost - Salvage value)/ Useful life of the asset $14,400,000 $0 Cost Less: Salvage value Depreciable cost Useful life of the asset a) Straight-line depreciation expense Tax Rate b) Annual depreciation tax shield $14,400,000 (Cost - Salvage value) $2,880,000 [$14,400,000/5 years] 21% $604,800 [$2,880,000 x 21%)

Requirement-(c 5-year MACRS Depreciation table (p)x (q) Depreciation Expense $2,880,000 $4,608,000 $2,764,800 $1,658,880 $1,658,880 $829,440 (r) x (s Depreciation Tax Shield Year Cost Tax Rate years 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% $14,400,000 $14,400,000 $14,400,000 $14,400,000 $14,400,000 $14,400,000 21% 21% 21% 21% 21% 21% $604,800 --> Dep. Tax shield for year-1 $967,680 $580,608 $348,365 $348,365 $174,182 1 2 4 Requirement-(d In order to enioy tax savings by way of annual depreciation tax shield, MACRS depreciation schedule shall be chosen because tax shield is higher during initial years under MACRS depreciation schedule. It means that the present value of future annual depreciation tax shield will be higher under MACRS than straight-line depreciation. MACRS depreclatioe shall Sent value of future annual depreciatic