Question

As the capital budgeting director of Union Mills Inc., you are analyzing the replacement of an automated loom system. The old system was purchased 5 years ago for $200,000; it is in CCA class 8; it has 5 years of remaining life; however, due to technological change there is no resale value for the system. The new system has a price of $300,000, plus $50,000 in installation costs. The new system falls into the same CCA class, has a 5-year economic life, a $100,000 after-tax salvage value, and will require a $20,000 increase in working capital at the beginning which will be recovered at the end of five years. The new system will decrease operating costs by $90,000 per year. The firm has a marginal tax rate of 40%, and the appropriate required rate of return for this project is 12%. What is the net present value of replacing the loom? At what level of pre tax operating savings will the project NPV be zero? The CCA rate applicable is 30% and half year rule is applicable.

Answer 1

		DEPRECIATION OF OLD SYSTEM
		Year(frompurchase date)	1	2	3	4	5	6	7	8	9	10
	A	Beginning Bookvalue	$200,000	$140,000	$98,000	$68,600	$48,020	$33,614	$23,530	$16,471	$11,530	$8,071
	B=A*30%	Depreciation	$60,000	$42,000	$29,400	$20,580	$14,406	$10,084	$7,059	$4,941	$3,459	$2,421
	C=A-B	Ending Book value	$140,000	$98,000	$68,600	$48,020	$33,614	$23,530	$16,471	$11,530	$8,071	$5,650
	N	Year FromToday	1	2	3	4	5
	D1	Depreciation 0f old System	$10,084	$7,059	$4,941	$3,459	$2,421
		DEPRECIATION OF NEW SYSTEM
	N	Year(from today)	1	2	3	4	5
	A2	Beginning Bookvalue	$350,000	$245,000	$171,500	$120,050	$84,035
	D2=A*30%	Depreciation	$105,000	$73,500	$51,450	$36,015	$25,211
	C2=A2-D2	Ending Book value	$245,000	$171,500	$120,050	$84,035	$58,825
		Present value of Cash Flow=(Cash Flow)/((1+i)^N)
		i=discount Rate =Requred rate of return =12%=0.12
		N=Year of Cash Flow