Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just

Question

Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just ordered a new kiln for $530,000. Of this sum, $63,000 is described by the supplier as an installation cost. Ms. Potts does not know whether the Internal Revenue Service (IRS) will permit the company to treat this cost as a tax-deductible first-year deductible expense or as a capital investment. In the latter case, the company could depreciate the $63,000 using the five-year MACRS tax depreciation schedule.

Assume the tax rate is 40% and the opportunity cost of capital is 8%. Calculate the value of the tax shield 1 and tax shield 2. (Note: Use Tax shield 1 as an expense treatment and tax shield 2 as 5 year MACRS.)

Assume the tax rate is 40% and the opportunity cost of capital is 8%. Calculate the value of the tax shield 1 and tax shield 2. (Note: Use Tax shield 1 as an expense treatment and tax shield 2 as 5 year MACRS.)

Explanation / Answer

Particulars/Year 1 2 3 4 5 6 Depriciation Rate 20 32 19.2 11.52 11.52 5.76 Case (1) when 63000 included in cost of the asset, Depriciation is on 530000 106000 169600 101760 61056 61056 30528 Tax Shield @40% 42400 67840 40704 24422.4 24422.4 12211.2 PV @8% 39259.26 58161.87 32312.15 17951.19 16621.48 7695.13 NPV Tax Shield 172001.07 Case (2) when 63000 excluded from cost of the asset, Depriciation is on (530000-63000)=467000 93400 149440 89664 53798.4 53798.4 26899.2 Inslallation Expense 63000 Total 156400 149440 89664 53798.4 53798.4 26899.2 Tax Shield @40% 62560 59776 35865.6 21519.36 21519.36 10759.68 PV @8% 57925.93 51248.29 28471.27 15817.37 14645.71 6780.42 NPV Tax Shield 174888.99

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