Question

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?

Answer 1

Depreciation
Cost	370,000
Depreciation for Year 1	37,000
(370,000 x 1/2 x 20%)
Balance at the beg of Year 2	333,000
Depreciation for Year 2	66,600
(333,000 x 20%)
Balance at the beg of Year 3	266,400
Depreciation for Year 3	53,280
(266,400 x 20%)

Post Tax Cashflows
	Particulars	Amount
1	Cost of Transformer 1 (Year 0)	(370,000)
2	Annual Operating Costs for Year 1-3	(80,000)
	Add: Tax savings @ 35%	28,000
	Post-tax operating costs [-80,000 + 28,000]	(52,000)
3	Tax Savings on Depreciation:
	Year 1: 37,000 x 35%	12,950
	Year 2: 66,600 x 35%	23,310
	Year 3: 53,280 x 35%	18,648
4	Salvage Value	40,000
	Note
1	There is no tax savings for cost incurred for the transfromer.
2	Negative cashflows are given in brackets

Calculation of NPV
Year	Cost	Post-tax operating costs	Tax Savings on Depreciation	Salvage Value	Total cashflow	PVF @ 10%	Present Value
0	(370,000)	-	-	-	(370,000)	1	(370,000)
1	-	(52,000)	12,950	-	(39,050)	0.909091	(35,500)
2	-	(52,000)	23,310	-	(28,690)	0.826446	(23,711)
3	-	(52,000)	18,648	40,000	6,648	0.751315	4,995
							(424,216)
NPV = $ 424,216