Question

Cost Cutting: CBD Inc, a processor of CBD oils, is analyzing a potential opportunity to cut costs. It can spend $1.5 Million today on the purchase and installation of a new automated processing line. The equipment will have a six-year life, at which time it can be sold for $250,000. The equipment qualifies as a Class 8 asset with a 20% CCA rate. Since the equipment will be purchased in 2020, it is subject to the Accelerated Investment Incentive rules, rather than the half-year rule. The benefit of installing the new equipment is a reduction in labor costs of $400,000 per year. The new process will lead to an immediate increase in Net Working Capital (NWC) of $25,000, which will be recovered at the conclusion of the project. The firm has a 30% corporate tax rate and it wants a 15% return. Should they undertake this cost-cutting program?

What is the correct value for Step #1-#6? ?(Value for each Step) Should they accept or reject? Is the NPV positive or negative?

Multiple Choice

MC	Step 1	Step 2	Step 3	Step 4	Step 5	Step 6
A	$1,500,000	$1,366,245	$376,650	$123,690	$16,412	-$15,648
B	$1,525,000	$1,059,655	$452,640	$98,654	$17,397	$17,369
C	$250,000	$1,263,755	$650,545	$108,082	$20,635	-$14,192
D	$400,000	$1,135,950	$273,913	$85,631	$18,528	-$18,354

Answer 1

									$
Year	Cash Inflow	Cash outflow	Net Cashflow	Depreciation	Net profit	Tax @30%	Cashflow after tax	PVF @ 15 %	Discounted Value
(a)	(b)	(c )	(d=b-c)	(e )	(f=d-e)	(g=f x 30%)	(h=d-g)	(i)	(J=h x i)
0	-	15,25,000	-15,25,000	-	-15,25,000	-	-15,25,000	1.00	-15,25,000
1	4,00,000	-	4,00,000	4,50,000	-50,000	-	4,00,000	0.87	3,47,826
2	4,00,000	-	4,00,000	3,00,000	1,00,000	30,000	3,70,000	0.76	2,79,773
3	4,00,000	-	4,00,000	3,00,000	1,00,000	30,000	3,70,000	0.66	2,43,281
4	4,00,000	-	4,00,000	3,00,000	1,00,000	30,000	3,70,000	0.57	2,11,549
5	4,00,000	-	4,00,000	1,50,000	2,50,000	75,000	3,25,000	0.50	1,61,582
6	4,00,000	-	4,00,000	-	4,00,000	1,20,000	2,80,000	0.43	1,21,052
6	2,50,000	-25,000	2,75,000	-	2,75,000	82,500	1,92,500	0.43	83,223
Net Present Value (NPV)	-76,714
WN 1:	Depreciation using the 20% CCA rate under Accelerated Investment Incentives, calculation of depreciation
	shall be one and half of 20% in first year as 30%, 20% in second to forth year and 10% in fifth year.
	Depreciation in 1st year : (15,00,000*30%)		4,50,000
	Depreciation in 2nd, 3rd and 4th year year : (15,00,000*20%)	3,00,000
	Depreciation in 5th year year : (15,00,000*10%)		1,50,000
WN 2:	Initial cost (1500000 + working capital cost 25000) = $ 15,25,000 and $ 25,000 reduction in cashflow
	in 6th year represents recovery of working capital.
Company should not take this cost cutting program as having negative NPV.
No any multiple choice matched exept Step 1 of B as cash outflow is same $ 15,25,000.