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Hydro One is evaluating buying two different transforms. Ø  Transformer #1: costs $370,000 has a 3 year...

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?

Solutions

Expert Solution

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

ekkarill92 answered 2 years ago
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