Question

Tim’s Brazilian Lunches is considering purchasing a new, energy-efficient grill. The grill will cost $20,000 and will be depreciated in an asset class that carries a CCA rate of 30%. It will be sold for scrap metal after 3 years for $7,500. The grill will have no effect on revenues but will save Tim’s $9,000 in energy expenses. The firm has other assets in this asset class. The tax rate is 35%.

a. What are the operating cash flows in years 1 to 3, not including any CCA calculation?

b. What is the present value of the tax shield if the discount rate is 12%?

c. If the discount rate is 12%, should the grill be purchased?

Answer 1

a) operating cash flow without any CCA calculation is as under

Particulars	1	2	3
Annual savings in energy expense	9000	9000	9000
Tax @ 35%	3150	3150	3150
Annual cash flow without CCA calculation	5850	5850	5850

b) First of all we need to find depreciation

Statement showing depreciation

Year	Opening balance	Depreciation rate	Depreciation= Depreciation rate *opening balance	Closing balance
1	20000	15%	3000	17000
2	17000	30%	5100	11900
3	11900	30%	3570	8330

Statement showing PV of Tax shield

Particulars	1	2	3	Total
Depreciation	3000	5100	3570
Tax shield @ 35%	1050	1785	1249.5
PV @ 12%	0.8929	0.7972	0.7118
Present value	938	1423	889	3250

C) Statement showing NPV

Particulars	0	1	2	3	Total
Cost of new grill	-20000
Annual Savings in energy power		9000	9000	9000
Depreciation		3000	5100	3570
PBT		6000	3900	5430
Tax @ 35%		2100	1365	1901
PAT		3900	2535	3530
Add: Depreciation		3000	5100	3570
Annaul cash flow		6900	7635	7100
Salvage value(7500+ 35%(8330-7500)) =7500+35%(830) =7500+290.5				7791
Total cash flow	-20000	6900	7635	14890
PVIF @ 12%	1	0.8929	0.7972	0.7118
Present value	-20000	6161	6087	10598	2846

Sunce NPV is positive, Grill should be purchased