Your firm needs a machine which costs $100,000, and requires $25,000 in maintenance for each year of its 3-year life. After 3 years, this machine will be replaced. The machine falls into the MACRS 3-year class life category. Assume a tax rate of 35% and a discount rate of 14%. What is the depreciation tax shield for this project in year 3?

Question

Quizplus · Accepted Answer

To calculate the depreciation tax shield, we first need to determine the depreciation expense for each year using MACRS. The depreciation schedule for the 3-year MACRS class is as follows:

Year 1: 33.33%
Year 2: 44.45%
Year 3: 14.81%
Year 4: 7.41%

For a $100,000 machine, the depreciation expense for each year is:

Year 1: $33,330
Year 2: $44,450
Year 3: $14,815

The depreciation tax shield for each year is calculated as:

Depreciation tax shield = Depreciation expense x Tax rate

So, for year 3, the depreciation tax shield is:

Depreciation tax shield = $14,815 x 0.35 = $5,183.50

Therefore, the best choice is B, with an explanation as above.

Your Firm Needs a Machine Which Costs $100,000, and Requires