Bruno is acquiring a new machine with a life of 5 years for use on its production line. The following data relate to this purchase: $\begin{array}{lr}
\text { Cost of new machine } & \$ 100000 \
\text { Annual cost savings in cash expenses } & 45000 \
\text { Terminal value } & 8000 \
\text { Maintenance required in the 4th year } & 5000 \
\text { Book value of the old machine } & 20000
\end{array}$ The new machine would replace an old fully-depreciated machine. The old machine can be sold for $15,000 at the time the new equipment is acquired. The income tax rate is 30%, and the discount rate is 12%. Bruno uses the straight-line method for depreciation on all machines (ignore the half-year convention).
The present value of the total tax savings from the depreciation tax shield is:
A) $19,899.60
B) $21,630.00
C) $46,432.40
D) $50,470.00

Question

Quizplus · Accepted Answer

The present value of the total tax savings from the depreciation tax shield can be calculated using the formula for the depreciation tax shield, which is the depreciation expense multiplied by the tax rate. The depreciation expense for the new machine is its cost ($100,000) minus its terminal value ($8,000), divided by its useful life (5 years), which equals $18,400 per year. The annual tax savings from the depreciation is then $18,400 * 30% = $5,520. The present value of these tax savings over 5 years, discounted at a 12% rate, can be calculated using the present value of an annuity formula or a financial calculator. The correct calculation leads to the present value of the tax shield being closest to $19,899.60.

Bruno Is Acquiring a New Machine with a Life of 5