Question

A&Y Inc. considers a 7-year project that requires $500,000 of investment in new machinery and $40,000 in NWC (that will stay constant for the entire life of the project). At the end of the project the equipment will be sold for a salvage value of $70,000. The cost of capital is 10%, the equipment belongs to a CCA class with d=40%, and the corporate tax rate is 30%

Problem 20: Prof Reynolds was able to use his industry connections to get a 3% discount on the equipment (i.e., it can be purchased for $485,000 instead of $500,000). By how much will this increase the project’s NPV?

Answer 1

Tax rate		30%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6	Year-7	Total
Cost		$           500,000	$          300,000	$           180,000	$               108,000	$             64,800	$             38,880	$        23,328
Dep Rate		40.00%	40.00%	40.00%	40.00%	40.00%	40.00%	40.00%
Depreciation	Cost * Dep rate	$           200,000	$          120,000	$             72,000	$                 43,200	$             25,920	$             15,552	$           9,331	$ 486,003
Closing WDV		$           300,000	$          180,000	$           108,000	$                 64,800	$             38,880	$             23,328	$        13,997
Calculation of annual depreciation after discount
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Year-6	Year-7	Total
Cost		$           485,000	$          291,000	$           174,600	$               104,760	$             62,856	$             37,714	$        22,628
Dep Rate		40.00%	40.00%	40.00%	40.00%	40.00%	40.00%	40.00%
Depreciation	Cost * Dep rate	$           194,000	$          116,400	$             69,840	$                 41,904	$             25,142	$             15,085	$           9,051	$ 471,423
Closing WDV		$           291,000	$          174,600	$           104,760	$                 62,856	$             37,714	$             22,628	$        13,577
Differential depreciation		$                6,000	$               3,600	$                2,160	$                   1,296	$                  778	$                   467	$              280
Tax benefit		$                1,800	$               1,080	$                   648	$                      389	$                  233	$                   140	$                84
Calculation of after-tax salvage value			Without discount	With discount
Cost of machine			$          500,000	$           485,000
Depreciation			$          486,003	$           471,423
WDV	Cost less accumulated depreciation	$             13,997	$             13,577
Sale price			$             70,000	$             70,000
Profit/(Loss)	Sale price less WDV		$             56,003	$             56,423
Tax	Profit/(Loss)*tax rate	$             16,801	$             16,927
Sale price after-tax	Sale price less tax		$             53,199	$             53,073
Differential salvage value			$                  126
Calculation of differential NPV
				(1)		10.00%
Year		Capital		Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		$             15,000			$                 15,000	1.0000	$        15,000.00
1				$        (1,800.00)	$                  (1,800)	0.9091	$        (1,636.36)
2				$        (1,080.00)	$                  (1,080)	0.8264	$            (892.56)
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