Question

An officer for a large construction company is feeling nervous. The anxiety is caused by a new excavator just released onto the market. The new excavator makes the one purchased by the company a year ago obsolete. As a result, the market value for the company’s excavator has dropped significantly, from $600,000 a year ago to $50,000 now. In 10 years, it would be worth only $3,000. The new excavator costs only $950,000 and would increase operating revenues by $90,000 annually. The new equipment has a 10-year life and expected salvage value of $175,000. The tax rate is 35 percent, the CCA rate, 25 percent for both excavators, and the required rate of return for the company is 14 percent. What is the NPV of the new ex

Answer 1

Calculation of NPV of new excavator
Year	0	1	2	3	4	5	6	7	8	9	10	NPV
Cost of new excavator	-$950,000
After tax salvage value of old excavator	$190,000
Increase in operating revenue		$90,000	$90,000	$90,000	$90,000	$90,000	$90,000	$90,000	$90,000	$90,000	$90,000
Tax @ 35% on operating revenue		-$31,500	-$31,500	-$31,500	-$31,500	-$31,500	-$31,500	-$31,500	-$31,500	-$31,500	-$31,500
Depreciation tax shield		$83,125	$62,344	$46,758	$35,068	$26,301	$19,726	$14,794	$11,096	$8,322	$6,241
After tax salvage value of new excavator											$132,474
Net Cash flow	-$760,000	$141,625	$120,844	$105,258	$93,568	$84,801	$78,226	$73,294	$69,596	$66,822	$197,216
x Discount Factor @ 14%	1.00000	0.87719	0.76947	0.67497	0.59208	0.51937	0.45559	0.39964	0.35056	0.30751	0.26974
Present Value	-$760,000	$124,232	$92,985	$71,046	$55,400	$44,043	$35,639	$29,291	$24,397	$20,548	$53,198	-$209,220
NPV of new Excavator =	-$209,220
After tax salvage value of old excavator
Sale Value	50000
Less : Book value at the end of 1st Year [$600000 - $150000]	450000
Loss on sale	-400000
Tax shield on Loss @ 35%	140000
After tax salvage value of old excavator	190000
Calculation of depreciation tax shield on new excavator
Year	Beginning Book Value	CCA rate	Depreciation	Depreciation Tax shield @ 35%
1	950,000.00	25%	237,500.00	83,125.00
2	712,500.00	25%	178,125.00	62,343.75
3	534,375.00	25%	133,593.75	46,757.81
4	400,781.25	25%	100,195.31	35,068.36
5	300,585.94	25%	75,146.48	26,301.27
6	225,439.45	25%	56,359.86	19,725.95
7	169,079.59	25%	42,269.90	14,794.46
8	126,809.69	25%	31,702.42	11,095.85
9	95,107.27	25%	23,776.82	8,321.89
10	71,330.45	25%	17,832.61	6,241.41
Total Accumulated depreciation			896,502.16
Calculation of after tax salvage value of new excavator
Sale Value	175,000.00
Less : Book value at the end of 10th year	53,497.84
Profit on sale	121,502.16
Tax @ 35%	42,525.76
After tax salvage value of new excavator	132,474.24