Question

1) Best Darn Glasses (BDR) is thinking of investing in a sandblasting machine for its glassware. It provides you with the following information: The initial investment for this project would be $235,000 in specialized machinery. According to CRA, this machine falls into a CCA class of 8%. There is the possibility of salvage of $6,000, although it’s not for sure. The risk-adjusted cost of capital is 12% and the company’s tax rate is 25%. Calculate the CCA tax shield under both scenarios – with and without salvage.

2) Using the information from above, calculate the project’s NPV if the following information were also provided to you: Cost of maintenance of the sandblasting machine is $35,000 per year, and the machine will only last 10 years. The salvage value, at that point, will be zero. The company’s revenues will be $170,000 per year with direct production costs of $27,000.

Answer 1

Facts given in this case : Investment is $235,000. Tax rate is 25%. Disc rate is 12%. Revenues are 170,000 per year. Life is 10 years. CCA (Capital Cost Allowance) Rate : 8%.

1. Calculation of tax shield :

   Tax shield can be calculated by using this formula : If Salvage value is zero.
   

   Value of tax shield
   CAPEX Amount	235000
   CAA Rate	8%
   Annual CAA Amount	18800
   Tax Rate :	25%
   Tax Shield during each year	4700

2. Calculation of tax shield :  If we consider Salvage value of 6000
   
   Annual depreciation charge = 235000 / 10 = 23,500 $
   Aftertax salvage value = 6000(.75) = 4500 $
   now, tax shield :

   Value of tax shield
   CAPEX Amount	235000
   Salvage	6000
   Net Depreciable Value	229000
   Annual CAA Amount	22900
   Tax Rate :	25%
   Tax Shield during each year	5725

   
   
   1. Now NPV :
      

      Ravenue	1,70,000.00
      Direct Cost	27,000.00
      Maintence Cost	35,000.00
      Total Cost	62,000.00
      Life	10 Years
      Capex Amount	2,35,000.00
      Salvage	-
      Disc Rate	12%

      
      NPV = Total discounted Inflows - total discounted outflows - Initial Investment at Y0
      

      Net Cash inflows per year

      1,08,000.00

      
      Total discounted cash inflows = ​​​​​ 108,000 x 5.65 = 610,224
      Initial Investment = 235000
      Net NPV = 610224 - 235000 =

      3,75,224.09