The Winchester Company plans to buy a machine for $500,000 and depreciate it ona straight-line basis over a 5-year period for tax purposes. There is no salvvage value (i.e. no resale value) expected at the end of the fifth year. The tax rate is 40% and the appropriate discount rate is 10%. Assume that the cash flows occur at the end of each year.
a. What is the present value of the tax shelter from the depreciation?
b. The machine described above will result in savings (i.e., lower incremental costs) of $200,000 per year before taxes for five years. Assume that the cash flows occur at the end of each year. The machine's useful life is 5 years. Should Winchester buy the machine? Why or why not? (Be sure to include the tax shelter from depreciation calculated in part a.)
c. Assume the cost of the machine can be expensed for tax purposes immediately (rather than being depreciated for tax purposes). Should Winchester buy the Machine?