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

Quizplus · Accepted Answer

The annual depreciation tax shield is calculated as the depreciation expense multiplied by the tax rate. The equipment costs $1.2 million and is depreciated straight-line over 3 years, so the annual depreciation expense is $1,200,000 / 3 = $400,000. The tax shield is $400,000 * 34% = $136,000.

You Own a High-Tech Manufacturing Entity