CMA Final · Strategic Financial Management · Leasing Decisions
Mahesh Logistics Ltd. can buy a vehicle for ₹8,00,000 or lease it. Under purchase, depreciation is on straight line over 4 years to nil salvage, tax rate is 25%. Discount rate is 10%. The PV of the depreciation tax shield is to be found. Annual depreciation tax shield and its PV are (PV annuity factor 4 years at 10% = 3.170):
The annual tax shield is ₹50,000 and its present value is ₹1,58,500. Depreciation is ₹2,00,000 a year, the 25% tax rate gives a shield of ₹50,000, and discounting for four years at 10% with factor 3.170 gives the present value.
- A₹50,000 per year; PV ₹1,58,500Correct
- B₹2,00,000 per year; PV ₹6,34,000
- C₹50,000 per year; PV ₹2,00,000
- D₹1,00,000 per year; PV ₹3,17,000
Explanation
Annual depreciation = 8,00,000/4 = 2,00,000. Tax shield = 25% x 2,00,000 = 50,000. PV = 50,000 x 3.170 = ₹1,58,500. Option ₹6,34,000 forgets to multiply by the tax rate.
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