23.11
11. Your company is purchasing a $1 million piece of equipment that can be depreciated to zero over 5 years (straight line). You have contracted to sell it for $300,000 at the end of the fourth year. Your corporate tax rate is 34%.
It will generate a depreciation tax shield equal to $200,000(.34)=$68,000 per year. When you sell it, it will have a book value of $200,000, so you will have to realize a gain of $100,000 that will be taxed at 34%, so you'll have a $34,000 tax payment.
b. Assume that the NPV of the project if equity financed is $250,000 assuming a discount rate of 10%. You are thinking about using $1 million in debt with an 8% annual coupon to finance the project. If you retire the debt when you sell the equipment, what will the new NPV be? ( 4pts)
The debt creates an interest tax shield. .08*1,000,000=$80,000
per year.
ITS=$80,000(.34)=$27,200 per year.