Depreciation Tax Shield | Finance

It is a technique under which depreciation of a company is managed as such there is tax saving due to this. This is called tax reduction technique. Under this technique, depreciation is deducted from the taxable income so that there is tax saving. Copy the link given below and paste it in new browser window to get more information on Depreciation Tax Shield:- http://www.transtutors.com/homework-help/finance/depreciation-tax-shield.aspx

1. DEPRECIATION TAX SHIELD

2. meaning Under this technique, depreciation is deducted from the taxable income so that there is tax saving. Due to deduction of this depreciation amount, the owner is able to save the tax amount which is the depreciation amount multiplied by the tax percentage.

3. Computing Depreciation Need to know which asset class for tax purposes Declining Balance Multiply the undepreciated capital cost (UCC) by the CCA rate (from the Tax Act) Half-year rule (can only deduct 50% of the usual amount in the year of acquisition of the asset) Can use PV of CCA Tax Shield Formula (see next page) Straight-line depreciation Very few assets are depreciated straight-line for tax purposes Depreciation = (Initial cost – salvage) / number of years

4. PV of CCA Tax Shield Formula Where: UCC = Initial cost of asset, including installation costs less any trade-in value received for an existing asset d = CCA rate Tc = Corporate Tax Rate k = discount rate (corporation’s cost of capital)

5. Example: Depreciation and Salvage You purchase equipment for $100,000 plus it costs $10,000 to have it delivered and installed. Based on past information, you believe that the equipment will have a salvage value of $17,000 in 6 years. The company’s marginal tax rate is 40%. If the applicable CCA rate is 20% and the required return on this project is 10%, what is the present value of the tax shield from CCA less the present value of the tax shield lost from salvage? The delivery and installation costs must be added to the initial cost of the asset and then depreciated

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