Bright Horizons Skilled Nursing Facility, an investor-owned company, constructed

Question

Bright Horizons Skilled Nursing Facility, an investor-owned company, constructed a new building to replace its outdated facility. The new building was completed on January 1, 2015, and Bright Horizons began recording depreciation immediately. The total cost of the new facility was $18,000,000, comprising (a) $10 million in construction costs and (b) $8 million for the land. Bright Horizons estimated that the new facility would have a useful life of 20 years. The salvage value of the building at the end of its useful life was estimated to be $1,500,000. Assuming a 40% income tax rate, how much did Bright Horizons save in income taxes for the year ended December 31, 2015, as a result of the depreciation recorded on the new facility (ie, what was the depreciation shield)? Does the depreciation shield result in cash or noncash savings for Bright Horizons? Explain.

Explanation / Answer

Depreciation per annum under Straight line method for 2015 = (10000000-1500000)/20 = $    4,25,000 Tax shield = 425000*40% = $    1,70,000 Depreciation tax shield results in cash savings, as it reduces the taxable income (without any cash outflow) because of which there would be lower cash flow on account of taxes.

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