Louie's Leisure Products is considering a project which will require the purchase of €1.4 million in new equipment.The equipment will be depreciated straight-line to a zero book value over the 7-
Year life of the project.Louie's expects to sell the equipment at the end of the project for 20% of its
Original cost.Annual sales from this project are estimated at €1.2 million.Net working capital equal
To 20% of sales will be required to support the project.All of the net working capital will be
Recouped at the end of the project.The ﬁrm desires a minimal 14% rate of return on this project.The
Tax rate is 34%.What is the value of the depreciation tax shield in year 2 of the project?

Question

Quizplus · Accepted Answer

The annual depreciation expense for the equipment is €200,000 (€1.4 million divided by 7 years). In year 2, the ending book value of the equipment is €1.2 million (€1.4 million minus 2 years of depreciation). The tax shield for year 2 is equal to the depreciation expense multiplied by the tax rate, or €68,000 (€200,000 multiplied by 0.34). Therefore, the best choice is B.

Louie's Leisure Products Is Considering a Project Which Will Require