DogChew Products needs to replace its rawhide tanning and molding equipment. It can be used for ﬁve years and will have no salvage value. The equipment costs $930,000. The ﬁrm can lease it for
$245,000 a year, or it can borrow the money to purchase the equipment at 9%. The ﬁrm's tax rate is
39%) The CCA rate is 20% (Class 8).
What is the present value of the depreciation tax shield?
A) $26,876
B) $277,177
C) $186,000
D) $84,074
E) $120,888

Question

Quizplus · Accepted Answer

The annual depreciation tax shield can be calculated as:

D = CCA rate * (Equipment cost – Salvage value)
D = 20% * ($930,000 – $0)
D = $186,000

The present value of the tax shield can then be calculated using the formula:

PV = D * (1 – T) * (1 + r)-t + D * (1 – T) * (1 + r)-t-1 + ... + D * (1 – T) * (1 + r)-(t+n-1)

where:
D = annual depreciation tax shield
T = tax rate
r = discount rate
t = time period (years)

Assuming a discount rate of 9%, a tax rate of 39%, and a time period of 5 years, the present value of the tax shield can be calculated as:

PV = $186,000 * (1 – 0.39) * (1 + 0.09)-1 + $186,000 * (1 – 0.39) * (1 + 0.09)-2 + ... + $186,000 * (1 – 0.39) * (1 + 0.09)-5
PV = $277,177.17

Therefore, the best choice would be to purchase the equipment and take advantage of the depreciation tax shield. The present value of the tax shield is higher than the annual leasing cost, making purchasing the equipment the more financially beneficial option.

DogChew Products Needs to Replace Its Rawhide Tanning and Molding