Mosely Enterprises is trying to decide whether to lease or buy some new equipment. The equipment costs $57,000, has a 4-year life and will be worthless after the 4 years. The cost of
Borrowed funds is 9.5 percent and the tax rate is 35 percent. The equipment can be leased for
$15,000 a year. What is the amount of the annual depreciation tax shield if the ﬁrm uses straight-line
Depreciation?

Question

Quizplus · Accepted Answer

To calculate the annual depreciation tax shield using straight-line depreciation, we first need to calculate the amount of depreciation per year:

Depreciation per year = (Equipment cost - Salvage value) / Useful life
Depreciation per year = ($57,000 - $0) / 4 years
Depreciation per year = $14,250

Next, we can calculate the annual depreciation tax shield:

Depreciation tax shield = Depreciation per year x Tax rate
Depreciation tax shield = $14,250 x 0.35
Depreciation tax shield = $4,987.50

If the firm chooses to lease the equipment, they will pay $15,000 per year but will not receive any tax benefits from depreciation. On the other hand, if they choose to buy the equipment and use straight-line depreciation, they will have an annual depreciation tax shield of $4,987.50.

Therefore, the best choice would be to buy the equipment and use straight-line depreciation.

Mosely Enterprises Is Trying to Decide Whether to Lease or Buy