Chapter 10 Questions:
Cash flow year 0 = -990,000
Cash flow years 1 through 5:
= Cash flow (1-tax rate) = 460,000(1 – 0.40) = $276,000
PV of CCATS = Initial cost (depreciation rate)(Tax rate)/req return + depreciation rate x (1 +(1.5 x req
r))/1 + depreciation rate
= 990,000(0.3)(0.4)/ 0.15 + 0.3 x (1 + 1.5(0.15))/1 + 0.15
= $281,217.39
NPV = - Initial investment + Cash Flow x PVIFA (15%,5) + PVCCATS
PVIFA = (1- (1+ r)-n/r) n = 5 r = 0.15
= -990,000 + 276,000 x PVIFA (15%, 5) + 281,217.39
= -990,000 + 276,000 x {1 – [1/1+0.15]5/0.15} + 281,217.39
= $216,412.20
Beginning: Cash flow year 0 = -990,000 – 47,200 = -$1,037,200
During: Cash flow years 1 through 5 = 460,000(1 – 0.4) = $276,000
End: Ending cash flow = 100,000 + 47,200 = $147,200
PV of CCATS = Initial cost (depreciation rate)(Tax rate)/req return + depreciation rate x (1 +(1.5 x req
r))/1 + depreciation rate (Subtract PV at end)
= 990,000(0.3)(0.4)/0.15 + 0.3 x (1 + 1.5(0.15))/1 + 0.15 – 100,000(0.3)(0.4)/0.15 + 0.3 x 1 /1.155
= $267,959.35
NPV = Beginning + During + End (For during include PVIFA)
= -1,037,200+ 276,000 x PVIFA(15%, 5) + (147,200)/(1.15)5 + 267959.35 = $229,138.57
Beginning:
Cash flow year 0 = -990,000 – 47,200 = -$1,037,200
During:
Cash flow years 1 through 5 = 460,000(1 – 0.4) = $276,000
End:
Ending cash flow = 100,000 + 47,200 = $147,200
PV of CCATS = Initial cost (depreciation rate)(Tax rate)/req return + depreciation rate x (1 +(1.5 x req
r))/1 + depreciation rate – salvage value (dep rate)(tax rate)/ IRR + Dep rate x 1/(1+ r)n
PV of CCATS = 990,000(0.25)(0.4)/0.15 + 0.3 x (1 + 1.5(0.15)) / 1 + 0.15 – 100,000(0.25)(0.4)/0.15 + 0.25
x 1 /1.155
= $251,211.89
NPV = -1,037,200+ 276,000 x PVIFA(15%, 5) + (147,200)/(1.15)^5 + 251,211.89 = $212,391.11
The NPV will be smaller because the Capital Cost Allowances are smaller early on.
Currently the firm has sales of 23,000($14,690) + (38,600) ($43,700) = $2,024,690,000.
With the introduction of a new mid-sized car its sales will change by (28,500) ($33,600) + (12,500)
($14,690) – (8,200) ($43,700) = $782,885,000.
This amount is the incremental sales and is the amount that should be considered when evaluating the
project.
a. EBIT = Sales – cost – depreciation (UCC x CCA rate)= $425,000 – $96,000 – $375,000 x 0.2 = $254,000
b. According to the bottom-up approach:
OCF = (S – C – D)(1 – T) + D = $254,000 x (1 – 0.35) + $75,000 = $ 240,100
T = company’s marginal tax rate
D = CCA rate
c. According to the tax shield approach:
OCF = (S – C)(1 – T) + T x D = ($425,000 – $96,000) x (1 – 0.35) + 0.35 x $75,000 = $240,100
T = company’s marginal tax rate
D = CCA rate
Solution:
Depreciation = Cost x CCA Rate x 1.5
Depreciation = $280,000 x 0.25 x (1.5) = $105,000
According to the top down approach:
OCF = (S – C) – (S – C – D) x T = ($650,000 – $490,000) – (650,000 – $490,000 – $105,000) x 0.38
= $139,100
According to the tax shield approach:
OCF = (S – C)(1 – T) + TD = ($650,000 – $490,000) x (1 – 0.38) + 0.38 x $105,000 = $139,100
Solution:
Method 1:
PV @ 13%(Costs) = - Initial Cost – Year 1 x PVIFA (13%, 3)
= -$6,700 – 400 x (1- (1+0.13)-3/0.13) = -$7,644.46
Method 2:
PV @ 13%(Costs) = -$9,900 – 620 x PVIFA (13%, 4) = -$11,744.17
Difference = $4,099.71 in favour of Method 1
Without replacement: On this basis we would need to know whether the benefit of 1 more year’s use
is sufficient to offset the additional cost of $4,099.71.
With replacement:
Method 1: EAC = -7,644.46/PVIFA(13%,3) = -$3,237.60
Method 2: EAC = -11,744.17/PVIFA(13%,4) = -$3,948.32
On this basis, Method 2 is again more expensive
Method 1: CF0 = -$6,700 (Cash flow initial)
PVCCATS = (6,700)(0.39)(0.25)(1.058)/[(0.13 + 0.25)(1.13)] = $1,817.96
PV(Costs) = -400(1 – 0.39)PVIFA (13%, 3) – 6,700 + 1,817.96 = -$5,458.16
EAC = PV (Costs)/PVIFA
= -$5,458.16/PVIFA(13%, 3) = -$2,311.65
Method 2: CF0 = -$9,900
PVCCATS = (9,900)(0.39)(0.25)(1.058)/[(0.13 + 0.25)(1.13)] = $2,686.25
PV(Costs) = -620(1 – 0.39)PVIFA (13%, 4) – 9,900 + 2,686.25 = -$8,338.70
EAC = -$8,338.70/PVIFA(13%, 4) = -$2,803.42
Method 2 is more expensive.
CF0 = -24,000,000 – 1,800,000 = -$25,800,000
ΔNWC= (15% × ΔSales) = – 15% (next period sales – current period sales)
PVCCATS = $4,371,754.99
NPV = -$25,800,000 + $4,371,754.99 + $4,650,635.59+ $4,135,126.40+ $5,140,496.35+
$6,145,882.34 + $5,237,114.80
= $3,881,010.47
The project should be accepted because NPV is positive.
New excavator costs = $950,000 but SV0=$50,000; Therefore, ∆CF0 = $900,000
∆Operating revenues
=$90,000 and
∆SV10= 175,000 – 3,000 = $172,000
PV of CCATS = 900,000(0.25)(0.35)/(0.14 + 0.25) x (1 + 0.5(0.14))/(1 + 0.14) - 175,000(0.25)(0.35)/ (0.14
+ 0.25) x 1 /(1.14)10
= $203,923.08
NPV = 90,000(1 – 0.35) x PVIFA (14%, 10) + 172,000 x PVIF (14%, 10) + 203,923.08 – 900,000
= -$344,548.78
Do not replace the existing excavator.
Operating costs A = Operating costs x (1-T) $80,000 (1 – 0.34) = $52,800
PVCCATSA = CdTc/ r + d x (1 + 0.5r/1+r) - SdTc/d + r x (1/(1 + r)t
= where:
C = capital cost of an asset acquired at beginning of year 1
d = CCA rate for the asset class to which the asset belongs
Tc = corporate tax rate
r = discount rate
S = salvage amount from the sale of the asset at the end of year
= 290,000 x (0.30)(0.34)/ 0.08 + (0.30) x (0.30)(1+0.5(0.08)) – 0 (no Salvage value)
$80,725.15
PV(Costs A) = -$290,000 – $52,800 x PVIFA(8%, 4) + $80,725.15 = -$384,155.15
Operating costs B = $74,000(1 – 0.34) = $48,840
PVCCATSB = $104,385.96
PV(CostsB) = -$375,000 – $48,840 x PVIFA(8%, 6) + $104,385.96 = -$496,395.48
If the system will not be replaced when it wears out, then system A should be chosen, because it has a
lower present value of costs.
Operating costsA = $80,000(1 – 0.34) = $52,800
PVCCATSA = $80,725.15
PV(CostsA) = -$290,000 – $52,800 x PVIFA(8%, 4) + $80,725.15 = -$384,155.15
Operating costsB = $74,000(1 – 0.34) = $48,840
PVCCATSB = $104,385.96
PV(CostsB) = -$375,000 – $48,840 x PVIFA(8%, 6) + $104,385.96 = -$496,395.48
EAC = Equivalent Annual Cost = Costs/PVIFA (discount rate, time)
PVIFA = (1- (1+ r)-n/r)
EACA = -$384,155.15 / PVIFA(8%, 4) = -$115,984.43
EACB = -$496,395.48 / PVIFA(8%, 6) = -$107,377.98
If the system is replaced, system B should be chosen because it has a smaller EAC.