Consider a replacement project, replacing Asset A with Asset B. Asset A cost $100,000 and was classified as a 5-year MACRS asset when it was acquired three years ago, and Asset B also costs $100,000 and is classified as a 5-year asset. The company's marginal tax rate is 35 percent. The change in the depreciation tax shield for this replacement decision for the first year of operations for Asset A is closest to:

Question

Quizplus · Accepted Answer

The change in the depreciation tax shield for the first year of operations for Asset A can be calculated by comparing the depreciation expenses of both assets and their impact on the tax shield. For a 5-year MACRS asset, the depreciation rates for the first three years are 20%, 32%, and 19.2%, respectively. Since Asset A has been in use for three years, its fourth-year depreciation rate would be 11.52%. Asset B, being new, would have a first-year depreciation rate of 20%.The depreciation expense for Asset A in its fourth year is $100,000 * 11.52% = $11,520. The depreciation expense for Asset B in its first year is $100,000 * 20% = $20,000. The difference in depreciation expenses is $20,000 - $11,520 = $8,480.The change in the depreciation tax shield is the difference in depreciation expenses multiplied by the tax rate: $8,480 * 35% = $2,968.

Consider a Replacement Project, Replacing Asset a with Asset B