Question

A firm is thinking about launching a new product. The initial investment in equipment is $600,000. The project has an estimated life of five years. The revenue per year is estimated to be $400,000, and operating costs per year is estimated to be $200,000.

The investment in the net working capital will be $40,000 at the beginning of the project; 40% of this will be recovered at the end of year 4, and the rest at the end of year 5. The tax rate is 30% and the CCA rate for depreciation purposes is 20%. The equipment can be sold at the end of the project for $60,000.

There is an on-going feasibility study regarding the project. The feasibility study is done by ACDT Consulting Group. They have been paid $50,000 a year ago, and they will be paid another $50,000 today. The cost of capital for the project is 10%. Calculate the NPV of the project to see if the company should undertake this project.

Answer 1

given cca rate = 20%

but in1st year we take only half rate i.e., 10%

cca rate is declining value method

above image shows formulas

calculation of after tax salvage value:

book value after year 5 = 600000 - (60,000 + 108000 +86400 + 69120 + 55296)

= 221184

sale value = 60,000

loss = 60,000 - 221184 = -161184

tax benefit on loss = 161184 * 0.3 = 48355.2

net salvage value = 60000 + 48355.2 = 108355.2

since NPV is positive project can be under taken.

amount paid to consulting group is sunk cost . so this need not be considered while taking decission.

(note : in case of any further clarification please comment below)