Question

 XYZ inc. considers an investment project that requires $500,000 in new equipment and $40,000 in extra NWC at the beginning of the project (that will be recovered when the project ends). The projects will lead to an increase in operating pre-tax net revenue of $150,000 per year and will last for 5 years. At the end of the project (beginning of year t=6), the equipment can be sold for the salvage value of $120,000. The equipment belongs to the CCA class with d=30%, the corporate income tax rate is 40% and the cost of capital is 11%

 Problem 8: Find CCA for the first year

 Problem 9: Find after-tax TOTAL cash flow for the THIRD year

 Problem 10: Find UCC at the end of the project (end of year t=5)

 Problem 11: Find PV of the operating cash flow (as we did in the "formula method") Problem 12: Find PV of the total tax shield from depreciation (as we did in the "formula method")

 Problem 13: Find PV of the salvage value

Answer 1

Problem 8) Find CCA for the first year.

CCA (Capital Cost Allowance) is calculated for the first year by,

Cost of equipment multiplied by 15%.

As per the CCA schedule, in the first year we only have to deduct half of the depreciation rate and for the rest of the year, full rate is taken to depreciate the declining balances.

CCA for year 1 = 500,000 * 15% = 75000

Note - Asterisk(*) is used to show multiplication sign.

Problem 9) Find after-tax total cashflow for the third year.

Cash flow for the third year includes after-tax operating evenue and depreciation tax savings.

After tax operating revenue = 150,000 - 40%= 150,000 - 60,000 = 90,000

Depreciation tax savings for year 3 = Declining Balance of the equpment multiplied by 30%. The found depreciation is multiplied by 40% (tax rate).

297,500 * 30% = 89,250

89,250 * 40% = 35,700.

Total after tax cash flow for year 3 = 90,000 + 35,700 = 125,700

Problem 10) Find UCC at the end of the project.

Year    Beg UCC    CCA End UCC

1 500,000    75,000    425,000

2 425,000    127,500    297,500

3 297,500 89,250 208,250

4 208,250 62,475 145,775

5 145,775 43,733    102,042

So UCC of the equipment at the end of 5th year is 102,042.

All these figures are not the present value because the question doesn't mention to convert into PV.

Problem 11) Find PV of operating cashflow.

PV of the operating cash flow could be found using the Annuity table factor for 5 year at 11% (cost of capital).

PV of Annuity for 5 years at 11% = 3.696

After tax operating cash flow = 90,000

PV of the operating cash flow = 90,000 * 3.696 = 332,640.

Problem 12) Find PV of the total tax shield from depreciation.

The depreciation amount for 5 years are 75,000 , 127,500 , 89,250 , 62,475, and 43,733.

Convert these into the tax shield part by multipliying the depreciation amount with the tax rate.

And then multiply it by the present value factor . And then add all the values to get the PV of the total depreciation tax shield.

75,000 * 40% = 30,000 * 0.9009 = 27,027

127,500 * 40% = 51,000 * 0.8116 = 41,392

89,250 *40% = 37,500 * 0.7312 = 27,420

62,475 *40% = 24,990 * 0.6587 = 16,461

43,733 * 40% = 17,493 * 0.5935 = 10,382

PV of total depreciation tax shield = 122,682.

Problem 13) Find PV of the salvage value.

Salvage value = 120,000

PV factor for the year 5 = 0.5935

PV of the saalvage value = 120,000 * 0.5935 = 71,220