In: Accounting
Hydro One is evaluating buying two different transforms.
Ø Transformer #1: costs $370,000 has a 3 year life, has pre-tax operating cost of $80,000 per year.
Ø Transformer #2: costs $475,000 has a 5 year life, has pre-tax operating cost of $30,000 per year.
Ø Both transformers are Class 8 (CCA rate of 20% per year) and both have a savage value of $40,000.
The firm’s tax rate is 35% and discount rate is 10%
1. What is the NPV for Transformer #1?
2.What is the PVCCATS for Transformer #1?
3. What is the NPV for Transformer #2?
4. What is the PVCCATS for Transformer #2?
5. What is the EAC for Transformer #1?
6. What is the EAC for Transformer #2?
Ø Transformer #1: costs $370,000 has a 3 year life, has pre-tax operating cost of $80,000 per year.
Ø Transformer #2: costs $475,000 has a 5 year life, has pre-tax operating cost of $30,000 per year.
Ø Both transformers are Class 8 (CCA rate of 20% per year) and both have a savage value of $40,000.
The firm’s tax rate is 35% and discount rate is 10%
.
1. What is the NPV for Transformer #1?
.
NPV = PV of Cash flow - initial cost
.
Year |
0 |
1 |
2 |
3 |
Pre tax operating cost (before adjusting CCA deduction ) |
-$80000 |
-$80000 |
-$80000 |
|
CCA deduction |
370000*10% =-37000 |
333000*20% =-66600 |
266400*20% =-53280 |
|
Pre tax cost (after CCA deduction adju.) |
-117000 |
-146600 |
-133280 |
|
Tax benefit |
40950 |
51310 |
46648 |
|
Cash flow |
-76050 |
-95290 |
-86632 |
|
Initial cost |
-370000 |
|||
Salvage value |
80000 |
|||
Tax benefit from sale of transformer |
46592 |
|||
Net cash flow |
-370000 |
-76050 |
-95290 |
39960 |
PVIF @10% |
1 |
0.909091 |
0.826446 |
0.7513148 |
PV of cash flow |
-370000 |
-69136.37 |
-78752.04 |
30022.54 |
NPV |
-487865.87 |
.
Salvage value = 80000
Carrying value = 266400 - 53280 = 213120
Loss on sales = 80000 - 212120 = 113120
Tax benefits = 113120 * 35% = 46592
.
2.What is the PVCCATS for Transformer #1?
.
Year |
1 |
2 |
3 |
CCA deduction |
370000*10% =-37000 |
333000*20% =-66600 |
266400*20% =-53280 |
Tax rate |
35% |
35% |
35% |
Tax shield = deduction *tax rate |
12950 |
23310 |
18648 |
PVIF @10% |
0.909091 |
0.826446 |
0.7513148 |
PVCCATS each year |
11772.73 |
19264.46 |
14010.52 |
PVCCATS |
45047.70 |
.
3. What is the NPV for Transformer #2?
.
Year |
0 |
1 |
2 |
3 |
4 |
5 |
Pre tax operating cost (before adjusting CCA deduction ) |
-$30000 |
-$30000 |
-$30000 |
-$30000 |
-$30000 |
|
CCA deduction |
475000*10% =-47500 |
427500*20% =-85500 |
342000*20% =-68400 |
273600*20% =-54720 |
218880*20% =-43776 |
|
Pre tax cost (after CCA deduction adju.) |
-77500 |
-115500 |
-98400 |
--84720 |
-73776 |
|
Tax benefit |
27125 |
40425 |
34440 |
29652 |
25821.6 |
|
Cash flow |
-50375 |
-75075 |
-63960 |
-55068 |
-47954.4 |
|
Initial cost |
-475000 |
|||||
Salvage value |
80000 |
|||||
Tax benefit from sale of transformer |
33286.40 |
|||||
Net cash flow |
-475000 |
-50375 |
-75075 |
-63960 |
-55068 |
65332 |
PVIF @10% |
1 |
0.909091 |
0.826446 |
0.7513148 |
0.68301 |
0.62092 |
PV of cash flow |
-475000 |
-45795.46 |
-62045.43 |
-48056.22 |
-37612 |
40565.95 |
NPV |
-627943.16 |
.
Salvage value = 80000
Carrying value =218880 - 43776 = 175104
Loss on sales = 80000 - 175104 = 95104
Tax benefits = 95104 * 35% = 33286.40
.
4. What is the PVCCATS for Transformer #2?
.
Year |
1 |
2 |
3 |
4 |
5 |
CCA deduction |
475000*10% =-47500 |
427500*20% =-85500 |
342000*20% =-68400 |
273600*20% =-54720 |
218880*20% =-43776 |
Tax rate |
35% |
35% |
35% |
35% |
35% |
Tax shield = deduction *tax rate |
16625 |
29925 |
23940 |
19152 |
15321.6 |
PVIF @10% |
0.909091 |
0.826446 |
0.7513148 |
0.68301 |
0.62092 |
PVCCATS each year |
15113.64 |
24731.39 |
17986.48 |
13081 |
9513.49 |
PVCCATS |
80426 |
.
5. What is the EAC for Transformer #1?
.
EAC (equivalent annual cost ) = NPV / PV of interest factor annuity
.
PV of Transformer 2 = -487865.87
PV of interest factor annuity, @ 10%, 3 period = 2.486852.
EAC = -487865.87 / 2.486852 = -$196178.09
.
6. What is the EAC for Transformer #2?
.
EAC (equivalent annual cost ) = NPV / PV of interest factor annuity
.
PV of Transformer 2 = -627943.16
PV of interest factor annuity, @ 10%, 5 period = 3.7907867
.
EAC = -627943.16 / 3.7907867 = -$165649.83
.
*Transformer 2 is better, because it has lower EAC