Question

Ilana Industries, Inc., needs a new lathe. It can buy a new high-speed lathe for $1.04 million. The lathe will cost $35,900 to run, will save the firm $133,100 in labour costs, and will be useful for 12 years. Suppose that for tax purposes, the lathe will be in an asset class with a CCA rate of 25%. Ilana has many other assets in this asset class. The lathe is expected to have a 12-year life with a salvage value of $110,000. The actual market value of the lathe at that time will also be $110,000. The discount rate is 8% and the corporate tax rate is 35%.

        

What is the NPV of buying the new lathe?

Answer 1

Here

1. CCA = CCA Rate * UCC [ Here CCA Rate = 25% ]
   Value of UCC for First Year = Lathe Cost
2. UCC ( After Depreciation M/C Value) = UCC Previous Year -  CCA Current Year
3. Initial Investment = Lathe Cost
4. After Tax Savings from Operation = (Saving in labour cost  - M/C Running Cost) * ( 1 - Tax Rate) =  =(133100-35900)*(1-0.35) [  Saving in labour cost = 133100   M/C Running Cost = 35900 ]
5. Depreciation Tax Shield = CCA Value each Year * Tax Rate
6. After Tax Cash Flow from Salvage :
   1. Salvage Value (After 12 Years Operation) = 110000
   2. Depreciation Remaining = UCC Value after 12 Years =32943.4
   3. Taxable Amount = Salvage Value - Depreciation Remaining = 110000 - 32943.4 = 77056.8
   4. Tax Paid = Taxable Amount * Tax Rate =  77056.8 * 0.35 = 26969.8
   5. After-Tax Cash Flow from Salvage = Salvage Value - Tax Paid = 110000 - 26969.8 = 83,030.2
7. Net Cash Flow = Sum of ( Initial Investment +  After-Tax Savings from Operation + Depreciation Tax Shield + After-Tax Cash Flow from Salvage)
8. PV of Net Cash Flow = Net Cash Flow / ( 1 + Rate ) ^Year [ Rate = 8% ]
9. NPV = Sum of All PV of Net Cash Flow

NPV of buying the new lathe = - 258,609.4