Question

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?

Answer 1

	Equipment 1			Equipment 2
	Cash flow in $	PV Factor @10%	PV	Cash flow in $	PV Factor @10%	PV
Year 0	-           10,000,000	1	-10,000,000	-     14,000,000	1.00000	-14,000,000
Yr1	1,056,000	0.909091	960,000	1,554,000	0.90909	1,412,727
Yr2	1,056,000	0.826446	872,727	1,554,000	0.82645	1,284,298
Yr3	1,056,000	0.751315	793,388	1,554,000	0.75131	1,167,543
Yr4	1,056,000	0.683013	721,262	1,554,000	0.68301	1,061,403
Yr5	1,056,000	0.620921	655,693	1,554,000	0.62092	964,912
Yr5	1,000,000	0.620921	620,921
Yr6				1,554,000	0.56447	877,192
Yr7				1,554,000	0.51316	797,448
Yr7				1,200,000	0.51316	615,790
Total			- 5,376,008			- 5,818,687

Workings Yearly maintenance is net of tax (i.eMaintenance cost*(1-tax rate)) Equipment 1 Equipment 2 -144000 -126000 Savings in tax expense due to Yearly depreciation Equipment 1 Equipment 2 (purchase price * CCA* tax rate)    1,200,000               1,680,000 Net cash flow (Savings in Tax expense - Yearly maintenance net of tax) Equipment 1 Equipment 2    1,056,000               1,554,000

Conclusion Based on the above cash flow workings, equiment 1 is suggested for purchase compared to equiment 2 since the net cash outflow is less in equipment 1 compared to equipment 2