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Calculation of depreciation tax shield-Multiple Choice Question

Question

The Giant Corporation is considering investing in a new metal-shelving manufacturing machine that has an estimated life of three years.  The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. 

The metal-shelving manufacturing machine will result in sales of 2,000 metal-shelves in year 1.  Sales are estimated to grow by 10% per year each year through year three.  The price per metal-shelve that Giant will charge its customers is $18 each and is to remain constant.  The metal-shelves have a cost per unit to manufacture of $9 each.

Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts.  It is estimated that the Giant Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 5% of its annual sales in accounts payable.  The firm is in the 35% tax bracket, and has a cost of capital of 10%.

The depreciation tax shield (assuming the half-year rule is not applied for straight-line depreciation) for the Giant Corporation's project in the first year is closest to:

A) $8,000

B) $3,500

C) $2,800

D) $5,200

 

 

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