Final answer:
The question requires calculating the present value of tax benefits from the depreciation of new equipment. The equipment depreciates over 8 years, and the annual tax shield and the present value are calculated using the firm's tax rate and cost of capital.
Step-by-step explanation:
The question is asking us to estimate the present value of tax benefits from depreciation of new equipment, using given financial variables. Since the equipment purchase cost is $848,000, and it will depreciate to a book value of $152,000 over 8 years, the annual depreciation expense is:
($848,000 - $152,000) ÷ 8 years = $87,000 per year
The tax shield in each year will be that depreciation expense times the firm's tax rate:
$87,000 × 21% = $18,270 per year
To get the present value of these benefits, we must discount these annual savings back to present value using the firm's cost of capital, which is 11%. This can be done using the present value of an annuity formula:
PV = PMT × [1 - (1 + r)^(-n)] ÷ r
Where PMT is the annual tax shield, r is the discount rate, and n is the life of the equipment in years. In our case, the calculation becomes:
PV = $18,270 × [1 - (1 + 0.11)^(-8)] ÷ 0.11
Completing this calculation will give us the present discounted value of the tax benefits from depreciation.