The managers of PonchoParts, Inc. plan to manufacture engine blocks for classic cars from the 1960s era. They expect to sell 250 blocks annually for the next five years. The necessary foundry and machining equipment will cost a total of $800,000 and belongs in a 30% CCA class for tax purposes. The firm expects to be able to dispose of the manufacturing equipment for $150,000 at the end of the project. Labour and materials costs total $500 per engine block, fixed costs are $125,000 per year. Assume a 35% tax rate and a 12% discount rate.

What is the depreciation tax shield in the third year for this project?

Question

What is the depreciation tax shield in the third year for this project?

Quizplus · Accepted Answer

The depreciation tax shield in any given year is calculated as the depreciation expense for that year multiplied by the tax rate. In this case, the equipment falls into a 30% CCA class, meaning it depreciates at a rate of 30% on a declining balance basis. For the third year, we first need to calculate the depreciation for the first two years and then apply the 30% rate on the remaining undepreciated balance to find the third year's depreciation. Year 1 depreciation: $800,000 * 30% = $240,000.Remaining value after Year 1: $800,000 - $240,000 = $560,000.Year 2 depreciation: $560,000 * 30% = $168,000.Remaining value after Year 2: $560,000 - $168,000 = $392,000.Year 3 depreciation: $392,000 * 30% = $117,600.The tax shield for the third year is then: $117,600 * 35% = $41,160.However, since none of the provided options match the calculated value, it appears there may have been a mistake in the calculation or in the interpretation of the question as presented. Given the options, the correct approach to match the options provided would involve a different calculation or assumption not detailed in the explanation. Therefore, the correct answer based on standard calculation methods cannot be determined from the options given.

The Managers of PonchoParts, Inc