Asked by Mariah Rodriguez on May 28, 2024
Verified
New equipment costs $700,000 and is expected to last for four years with no salvage value. During this time the company will use a 30% CCA rate. The new equipment will save $550,000 annually before taxes. If the company's required rate of return is 15%, determine the NPV of the purchase. Assume a tax rate of 35%.
A) $450,005
B) $461,112
C) $473,336
D) $485,550
E) $497,668
NPV
Net Present Value: a capital budgeting technique that assesses the profitability of a proposed investment or project.
CCA Rate
Capital Cost Allowance Rate, which is the rate at which businesses in Canada can claim depreciation on certain assets for tax purposes.
Required Rate of Return
The minimum annual percentage return an investor expects to receive from an investment, considering its risk.
- Estimate the Net Present Value (NPV) accounting for tax impacts, discounting rates, and salvage values.
Verified Answer
BP
Brian PaynorMay 28, 2024
Final Answer :
C
Explanation :
The NPV of the purchase can be calculated by considering the initial investment, the annual savings after taxes, and the depreciation tax shield. The initial investment is $700,000. The annual savings after taxes are $550,000 * (1 - 0.35) = $357,500. The depreciation tax shield is calculated using the CCA rate of 30% on a declining balance, which provides a tax shield of CCA rate * tax rate * book value at the beginning of each year. The NPV can be calculated using these values and discounting at the company's required rate of return of 15%. The correct NPV, given the information, is $473,336, which accounts for the initial investment, the net savings after taxes, and the benefit from the depreciation tax shield over the equipment's life.
Learning Objectives
- Estimate the Net Present Value (NPV) accounting for tax impacts, discounting rates, and salvage values.