Depreciation tax shield
Depreciation tax shield is the cash tax saving a project earns because depreciation is deductible, equal to depreciation expense multiplied by the corporate tax rate.
See it move
A machine costing €100,000, depreciated straight-line over 5 years, gives annual depreciation of €20,000. Multiplying by the 25% corporate tax rate gives a tax shield of €20,000 times 0.25, or €5,000 — the actual cash saved each year, since depreciation itself is only an accounting charge, not a cash outflow.
The formula
Variables
- Annual depreciation expense (€)
- Corporate tax rate (decimal)
The cash tax saving generated each period because depreciation reduces taxable income, even though depreciation itself is not a cash outflow.
Check yourself
A company buys equipment for €150,000, depreciated straight-line to zero over 10 years. The corporate tax rate is 30%. What is the annual depreciation tax shield?