Wable Inc. has provided the following data to be used in evaluating a proposed investment project: For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 5 years. The company uses a discount rate of 16%.
-When computing the net present value of the project, what is the annual amount of the depreciation tax shield? In other words, by how much does the depreciation deduction reduce taxes each year in which the depreciation deduction is taken?
A) $27,500
B) $77,000
C) $33,000
D) $64,167

Question

Wable Inc. has provided the following data to be used in evaluating a proposed investment project:  For tax purposes, the entire initial investment without any reduction for salvage value will be depreciated over 5 years. The company uses a discount rate of 16%.
-When computing the net present value of the project, what is the annual amount of the depreciation tax shield? In other words, by how much does the depreciation deduction reduce taxes each year in which the depreciation deduction is taken?
A) $27,500 
B) $77,000 
C) $33,000 
D) $64,167

Quizplus · Accepted Answer

The annual amount of the depreciation tax shield can be calculated using the formula:

Annual Depreciation Tax Shield = Depreciation Expense x Tax Rate

Depreciation Expense = Cost of Asset / Useful Life
Depreciation Expense = $550,000 / 5
Depreciation Expense = $110,000

Tax Rate = 40% (assuming a 40% corporate tax rate)

Annual Depreciation Tax Shield = $110,000 x 0.4
Annual Depreciation Tax Shield = $44,000

Therefore, the correct answer is (C) $33,000, which is the present value of the annual depreciation tax shield at a discount rate of 16% over 5 years.

Wable Inc Has Provided the Following Data to Be Used in in Evaluating