Exercise-18: Tax savings from depreciation tax shield

Learning objective:
This exercise illustrates the computation of tax saving caused by recording the annual depreciation expense. This saving is generally referred to as depreciation tax shield.

The Marshal company has just purchased an asset costing $420,000. The straight line method of depreciation will be used and the entire cost of the asset will be depreciated over 6 years. The tax rate of Marshal company is 30%.

Required:

Calculate annual tax savings from depreciation tax shield.

Solution:

The annual depreciation would be computed first and then multiplied by 30% or 0.30 to find the annual tax savings from depreciation tax shield.

Annual depreciation = $420,000 / 6 years
= $70,000

Annual tax savings from depreciation tax shield = $70,000 × 0.30
= $21,000

The Marshal company will save $21,000 tax per year.