Hint: In solving these problems, use the Capital Investment Analysis as a framework.

Tax Cuts and Jobs Act: Expensing immediately versus depreciating over time.

1. The PreFab Company plans to buy a machine for $500,000 and depreciate it on a straight-line basis over a 5-year period for tax purposes. There is no salvage 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?

2. 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 machines useful life is 5 years. Should PreFab buy the machine? Why or why not? (Be sure to include the tax shelter from depreciation calculated in part a.)

3. The recent change in regulations with the Tax Cuts and Jobs Act (2017) allows for capital investment, except for structures, to be fully and immediately deductible. PreFab can choose to either expense the machine immediately or depreciate it over 5 years. Which would you recommend? Should PreFab buy the machine? Why or why not?