Chapter 9, Problem 27P

Summary Introduction

Depreciation: Depreciation is a decline in the value of assets after some period of time due to use. It is charged on the cost of assets over the depreciable life of the asset.

Straight-line depreciation method: The amount of depreciation calculated in this method remains same over the useful life of the asset. This method is known as fixed installment method. Depreciation is calculated only one time and the same amount of depreciation is charged over the useful life of assets.

MACRS depreciation schedule: The depreciation method which allows the greater amount of subtraction in the value of assets. Under this method, assets are written off with the greater amount in the earlier year and with the smaller amount in the later year.

Depreciation tax shield: Depreciation tax shield is the tax saving which results from the ability to deduct the depreciation. It is the technique to reduce the depreciation from the taxable income which shows low taxable income and helps to save tax. Depreciation is noncash expenses because there is no flow of cash actually, thus company claim depreciation as a tax deduction to show lower income and pay less tax. Thus, depreciation tax shield is tax avoidance strategy.

a.

To Determine: Annual depreciation associated with the equipment.

b.

Summary Introduction

To Determine: Annual depreciation tax shield.

c.

Summary Introduction

To Determine: Depreciation tax shield under marcs depreciation schedule.

d.

Summary Introduction

To Determine: The schedule suitable if the corporate tax rate is expected to remain constant.

e.

Summary Introduction

To Determine: The method suitable if marginal tax rate will increase substantially over next five years.