Answer:
To calculate the present value of the depreciation tax shield, we need to determine the tax shield value for each year and then discount those values to the present using the discount rate.
The tax shield value for each year can be calculated by multiplying the depreciation expense by the tax rate. Since the investment of $10 million is depreciated straight-line over 5 years, the annual depreciation expense would be $10 million divided by 5, which is $2 million.
Tax shield value for each year: $2 million × 21% = $0.42 million
To calculate the present value, we discount each year's tax shield value using the discount rate of 8%. The formula for calculating the present value is:
Present value = Tax shield value / (1 + Discount rate)^Year
Let's calculate the present value for each year:
Year 1: $0.42 million / (1 + 0.08)^1 = $0.39 million
Year 2: $0.42 million / (1 + 0.08)^2 = $0.36 million
Year 3: $0.42 million / (1 + 0.08)^3 = $0.34 million
Year 4: $0.42 million / (1 + 0.08)^4 = $0.31 million
Year 5: $0.42 million / (1 + 0.08)^5 = $0.29 million
To get the present value of the depreciation tax shield, we sum up the present values for each year:
Present value = $0.39 million + $0.36 million + $0.34 million + $0.31 million + $0.29 million
Present value ≈ $1.69 million
The correct answer, therefore, is not provided in the multiple-choice options. The present value of the depreciation tax shield is approximately $1.69 million.
Explanation: