The term tax shield refers to the amount of income tax saved by deducting depreciation for income tax purposes. Assume that Supreme Company is considering the purchase of an asset as of January 1, 2012. The cost of the asset with a five-year life and zero residual value is $100,000. The company will use the straight-line method of depreciation.
Supreme's income for tax purposes before recording depreciation on the asset will be $50,000 per year for the next five years. The corporation is currently in the 35% tax bracket.
Required:
i. Calculate the amount of income tax that Supreme must pay each year if the asset is not purchased.
ii. Calculate the amount of income tax that Supreme must pay each year if the asset is purchased.
iii. What is the amount of the depreciation tax shield?
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