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3 January, 11:24

Sway's Market is considering a project that will require the purchase of $1.4 million in new equipment. The equipment will be depreciated straight-line to zero over the 5-year life of the project. The firm expects to sell the equipment at the end of the project for 20 percent of its original cost. New net working capital equal to 10 percent of sales will be required to support the project. All of the new net working capital will be recouped at the end of the project. Annual sales are estimated at $750,000 with costs of $338,000. The required rate of return is 12 percent and the tax rate is 34 percent. What is the value of the depreciation tax shield in Year 2 of the project?

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  1. 3 January, 13:22
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    tax shield year 2 95,200

    Explanation:

    The tax shield will be the depreciation expense times tax rate

    Our first step is to calculate the depreciation expense:

    The equipment is worth 1.4 million and has a 5-years useful life

    It is being depreciate on straight-line

    depreciation per year

    equipment / useful life

    1.4 million / 5 = 0.28 = 280,000

    Now we apply the tax rate of 34%

    280,000 x 34% = 95,200

    This will be the tax shield on Year 2
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