Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just
ID: 2777981 • Letter: M
Question
Ms. T. Potts, the treasurer of Ideal China, has a problem. The company has just ordered a new kiln for $480,000. Of this sum, $58,000 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 expense or as a capital investment. In the latter case, the company could depreciate the $58,000 using the five-year MACRS tax depreciation schedule. http://lectures.mhhe.com/connect/0078034760/MACRS.JPG
Assume the tax rate is 35% 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.) (Do not round intermediate calculations. Round your answers to the nearest dollar amount.)
Tax shield 1 $
Tax shield 2 $
Explanation / Answer
Tax shield 1 as an expense treatment
we consider installation cost of new kiln is as expense of revenue expenditure which is deductible for tax purpose.
Therefore, $58000 will be charged to Profit and Loss Account for the year
and only $ 480000 of new kiln will be shown as fixed assets in Balance sheet as on year ended.
Tax Shield 2 as 5 year MACRS :
Year Depreciation for current year
0 0
1 $ 2320 (11600 * 0.20)
2 $ 3712 (11600 * 0.32)
3 $ 2227 (11600 * 0.192)
4 $ 1336 (11600 * 0.1152)
5 $ 1336 (11600 * 0.1152)
6 $ 668 (11600 * 0.0576)
Total depreciation $ 11599
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