Exam 22: Capital Budgeting: a Closer Look

For Years 1 through 6 Better Products Ltd. had annual net income of $20,000, CCA of $40,000 each year, a 40 percent tax rate, a discount rate of 10 percent and annual cash sales of $200,000. The depreciable assets of Better Products belong in several different classes under the Income tax Act, have a salvage value of zero at the end of six years, and were all bought new at the beginning of Year 1. The present value factors, in simplified form, for 10 percent are: -Biermann Equipment is a publicly held corporation required to pay income taxes. For the current year it had revenues of $5,000,000 and cash expenses of $3,000,000, and claimed CCA of $200,000. The company has a 30 percent tax rate. What would be the net cash flow for the current year if all revenues were received in cash?

Using the certainty equivalent approach means that

Use the information below to answer the following question(s). Barry operates a shop in a resort in an area known for its high inflation rate. The inflation rate for the last few years has been averaging 3 percent a month. His long-term real rate of return is 12 percent, or 1 percent a month. On April 1 he anticipates that real dollar sales during the summer will be as follows: -What will Barry's sales figures be for each month, respectively, assuming the owner uses the real rate approach?

Clock Manufacturing Company purchased a new piece of equipment at a cost of $60,000 at the beginning of the year. For tax purposes the machine is a Class 8 asset (20% declining balance). The company has a 34 percent income tax rate. Assume that the company has no other Class 8 assets during the period. Required: a. Compute the amount of tax savings from CCA for the first three years. b. Compute the amount of tax savings from CCA for the first three years using a required rate of return of 12 percent.

The differential approach is based on the concept of relevance.

Which of the following statements is False?

Headwaters Ltd. is considering purchasing a new asset. It has a cost of $1,350,000, an expected 6 year life and a salvage value of $90,000. The equipment would qualify as a class 8 (20% CCA) asset and Headwaters has a required rate of return of 11% and an effective tax rate of 32%. Required: Calculate the tax shields that are generated from the purchase of this asset. Assume the asset will be placed in a pool and the pool will continue upon disposition. For tax purposes the disposition will occur on day 1 of Year 7. What is the net tax effect of the asset acquisition?

Avilas Corp. has a marginal tax rate of 25%, and is considering the following two capital projects: Additional data (for interest rate of 10%, 5 periods): Required: Which project has a higher net after-tax present value?

The real rate of return is the rate of return which deals with the inflation element.

The NPV method always indicates the project or set of projects that maximizes the NPV of future cash flows.

The acquisition cost of the assets in a class, minus the CCA claimed to date for that class, is referred to as the UCC of a particular class.

For Years 1 through 6 Better Products Ltd. had annual net income of $20,000, CCA of $40,000 each year, a 40 percent tax rate, a discount rate of 10 percent and annual cash sales of $200,000. The depreciable assets of Better Products belong in several different classes under the Income tax Act, have a salvage value of zero at the end of six years, and were all bought new at the beginning of Year 1. The present value factors, in simplified form, for 10 percent are: -What is the tax saving from CCA in each year?

Good Bread Bakery installed an oven costing $100,000 on January 1 of the current year. Due to unexpected advances in technology, the equipment's value was reduced to $24,000 in only one week. The equipment is class 8 which has a CCA rate of 20% for tax purposes. The incremental costs of operating the oven over four years is $80,000 annually, excluding depreciation. A new replacement machine with all the new advances can be purchased now for $120,000. It also has a useful life of four years and can be operated for $30,000 a year, excluding depreciation. The company's tax rate is 40 percent. Neither oven has a salvage value at the end of the four years. Assume that the company will replace the oven (whichever one it chooses) after the four years. Required: a. Calculate the relevant cash flows using both a total project approach and a differential approach if the company's required rate of return is 10 percent. b. What is the difference between the two methods?

CCA reduces taxable income, and therefore reduces tax payments and increases the firm's cash flow.

Which of the following are not considered in capital-budgeting?

Wilf Company acquired an additional Class 10 (30% declining balance) asset for $60,000. The UCC at the beginning of the year was $100,000. CCA in the current year is

The differential approach calculates the present value of all cash inflows and outflows under each alternative.

Depreciation tax deductions result in tax savings that partially offset the cost of acquiring the capital asset.

The total project approach calculates the future value of cash outflows and inflows that differ between the alternatives of using the old machine and replacing the old machine.

A company purchased computer equipment that is Class 10 for Income Tax purposes (Class 10 is declining balance, but with a 30% rate). The company made the following two journal entries: How is the $300 loss treated in discounted cash flow analysis?