Question

Canyon Buff Corp. is considering the purchase of a new piece of equipment which would cost $11,000. This equipment will have a five-year useful life and have a salvage value of $1,000 at the end of the five-year period. The marginal tax rate is 30% and the average tax rate is 20%. Assume a straight-line depreciation, the net effect of annual depreciation on the free cash flow is $_____ in each of the 5 years.

Answer 1

Tax shield on depreciation = 600

Step-by-step explanation:

given data

new piece of equipment = $11,000

salvage value = $1,000

marginal tax rate = 30%

average tax rate = 20%

time period = 5 year

to find out

net effect of annual depreciation on the free cash flow

solution

we know here cost of asset and Salvage value so we get depreciation cost

depreciation cost is = 11000 - 1000 = 10000

and

annual depreciation = 2000

so that Tax shield on depreciation will be

Tax shield on depreciation = 2000 × 30%

Tax shield on depreciation = 600