Calculate the Present Value of the Depreciation Tax Shield for an Asset

question 58

Essay

Calculate the present value of the depreciation tax shield for an asset in the 3-year class life costing $100,000. Three-year class percentages are 33.33%, 44.45%, 14.81%, and 7.41%, respectively for years 1 through 4. The firm has a 35% tax rate and a 10% cost of capital. Compare this present value to that calculated for straight-line depreciation with no salvage value.

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Definitions:

Variable Cost

Costs that vary directly with the level of production or sales volume, such as raw materials and direct labor.

Unit Contribution Margin

The difference between the selling price per unit and the variable cost per unit, showing how much each unit contributes to covering fixed costs and earning profit.

Operating Income

The profit earned from a firm's normal core business operations, excluding deductions of interest and taxes.

Fixed Costs

Expenses that do not change in proportion to the volume of goods or services a company produces.