You own a high-tech manufacturing entity. You would like to expand your operations but to do so you need to either lease or buy a $1.2 million piece of equipment for the next three years. The lease payments would be $475,000 a year for the three years. If the equipment is purchased, it will be depreciated straight-line to zero over the three-year period. The equipment will have no residual value at the end of the three years. Should the equipment be leased, the lessor and the lessee will both have marginal tax rates of 34%. The loan rate for your firm for this purpose is 8% pre-tax.

What is the amount of the annual depreciation tax shield?
A) $136,000
B) $166,250
C) $158,333
D) $272,000
E) $400,000

Question

You own a high-tech manufacturing entity. You would like to expand your operations but to do so you need to either lease or buy a $1.2 million piece of equipment for the next three years. The lease payments would be $475,000 a year for the three years. If the equipment is purchased, it will be depreciated straight-line to zero over the three-year period. The equipment will have no residual value at the end of the three years. Should the equipment be leased, the lessor and the lessee will both have marginal tax rates of 34%. The loan rate for your firm for this purpose is 8% pre-tax.

What is the amount of the annual depreciation tax shield?

What is the amount of the annual depreciation tax shield?
A) $136,000
B) $166,250
C) $158,333
D) $272,000
E) $400,000

Quizplus · Accepted Answer

The annual depreciation expense is calculated as the cost of the equipment divided by the useful life. Here, it's $1.2 million / 3 years = $400,000 per year. The depreciation tax shield is the depreciation expense multiplied by the tax rate, which is $400,000 * 34% = $136,000.

You Own a High-Tech Manufacturing Entity