This is the annual tax savings due to the depreciation. The tax savings due to the depreciation expense is called the depreciation tax shield. The question asks for the present value of the depreciation tax shield.
This is the present value of the depreciation expense. The question asks for the present value of the tax savings due to the depreciation expense. The tax savings due to the depreciation expense is called the depreciation tax shield.
This is $8,000 (the annual depreciation tax shield) × 6 years × .564 (the present value of $1 factor for 6 years at 10%). The annual depreciation tax shield is an annuity, and this is not the correct way to calculate the present value of an annuity. The present value of an annuity factor should be used.
The depreciation is $20,000 and the tax rate is .40. Therefore, the annual tax savings due to the depreciation will be $20,000 × .40, or $8,000. The tax savings due to the depreciation expense is called the depreciation tax shield. The present value of the total depreciation tax shield would be $8,000 discounted using the PV of an annuity factor for 10% for 6 years. $8,000 × 4.355 = $34,840.
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