Question
In: Finance
Maple Leafs Sports & Entertainment is considering purchasing one of the following two pieces of lighting...
Maple Leafs Sports & Entertainment is considering purchasing one of the following two pieces of lighting equipment. Equipment A has a purchase price of $10 million and will cost, $240,000 pre-tax, to operate on an annual basis. This equipment will have to be replaced every 5 years and has a salvage value of $1 million. Equipment B on the other hand, has an initial cost of $14 million and costs $210,000 pre-tax, annually to operate. This equipment has a useful life of 7 years with a salvage value of $1.2 million. Both equipment sets are in an asset class with a CCA Rate of 30% and are otherwise identical. The income tax rate is 40 percent and the appropriate discount rate is 10%. Which equipment should the company purchase and why?
Solutions
Expert Solution
For equipment A
Statement showing depreciation
| Year | Opening balance | Depreciation rates | Depreciation | Closing balance |
| 1 | 10000000 | 15.00% | 1500000 | 8500000 |
| 2 | 8500000 | 30.00% | 2550000 | 5950000 |
| 3 | 5950000 | 30.00% | 1785000 | 4165000 |
| 4 | 4165000 | 30.00% | 1249500 | 2915500 |
| 5 | 2915500 | 30.00% | 874650 | 2040850 |
Statement showing terminal cash flow
| Particulars | Amount |
| Selling value | 1000000 |
| BV | 2040850 |
| Loss | 1040850 |
| Tax savings @40% | 416340 |
| Cash inflow(1000,000+413640) | 1416340 |
Statement showing Equivalent annual cost
| Particulars | 0 | 1 | 2 | 3 | 4 | 5 | |
| Purchase price | -10000000 | ||||||
| Pre tax cost | -240000 | -240000 | -240000 | -240000 | -240000 | ||
| Depreciation | -1500000 | -2550000 | -1785000 | -1249500 | -874650 | ||
| PBT | -1740000 | -2790000 | -2025000 | -1489500 | -1114650 | ||
| Tax savings @ 40% | 696000 | 1116000 | 810000 | 595800 | 445860 | ||
| PAT | -1044000 | -1674000 | -1215000 | -893700 | -668790 | ||
| Less: depreciation | 1500000 | 2550000 | 1785000 | 1249500 | 874650 | ||
| Cash flow | 456000 | 876000 | 570000 | 355800 | 205860 | ||
| Salvage value | 1416340 | ||||||
| Total cash flow | -10000000 | 456000 | 876000 | 570000 | 355800 | 1622200 | |
| PVIF @ 10% | 1 | 0.9091 | 0.8264 | 0.7513 | 0.6830 | 0.6209 | |
| Present value | -10000000 | 414545 | 723967 | 428249 | 243016 | 1007259 | -7182963 |
| PVIFA(10%,5) | 3.7908 | ||||||
| Equivalent cost | -1894841 |
For equipment B)
Statement showing depreciation
| Year | Opening balance | Depreciation rates | Depreciation | Closing balance |
| 1 | 14000000 | 15.00% | 2100000 | 11900000 |
| 2 | 11900000 | 30.00% | 3570000 | 8330000 |
| 3 | 8330000 | 30.00% | 2499000 | 5831000 |
| 4 | 5831000 | 30.00% | 1749300 | 4081700 |
| 5 | 4081700 | 30.00% | 1224510 | 2857190 |
| 6 | 2857190 | 30.00% | 857157 | 2000033 |
| 7 | 2000033 | 30.00% | 600009.9 | 1400023.1 |
Statement showing terminal value
| Particulars | Amount |
| Selling value | 1200000 |
| BV | 1400023.1 |
| Loss | 200023.1 |
| Tax savings @40% | 80009.24 |
| Cash inflow(1200,000+80009.24) | 1280009.24 |
Statement showing Equivalent annual cost
| Particulars | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | Total |
| Purchase price | -14000000 | ||||||||
| Pre tax cost | -210000 | -210000 | -210000 | -210000 | -210000 | -210000 | -210000 | ||
| Depreciation | -2100000 | -3570000 | -2499000 | -1749300 | -1224510 | -857157 | -600010 | ||
| PBT | -2310000 | -3780000 | -2709000 | -1959300 | -1434510 | -1067157 | -810010 | ||
| Tax savings @ 40% | 924000 | 1512000 | 1083600 | 783720 | 573804 | 426862.8 | 324004 | ||
| PAT | -1386000 | -2268000 | -1625400 | -1175580 | -860706 | -640294 | -486006 | ||
| Less: depreciation | 2100000 | 3570000 | 2499000 | 1749300 | 1224510 | 857157 | 600009.9 | ||
| Cash flow | 714000 | 1302000 | 873600 | 573720 | 363804 | 216862.8 | 114004 | ||
| Salvage value | 1280009 | ||||||||
| Total cash flow | -14000000 | 714000 | 1302000 | 873600 | 573720 | 363804 | 216862.8 | 1394013 | |
| PVIF @ 10% | 1 | 0.9091 | 0.8264 | 0.7513 | 0.6830 | 0.6209 | 0.5645 | 0.5132 | |
| Present value | -14000000 | 649091 | 1076033 | 656349 | 391858 | 225894 | 122413 | 715349 | -10163013 |
| PVIFA(10%,7) | 4.8684 | ||||||||
| Equivalent cost | -2087547 |
Equipment A should be purchased as it has lower equivalent annual cost
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