Exam 22: Capital Budgeting: a Closer Look

A company is considering the purchase of some equipment that in the second year of operation should cause an increase in sales of $200,000, an increase in cash expenses of $120,000, and CCA of $60,000. If the appropriate tax rate is 40%, what will be the after-tax effect on net income in year two?

A company purchased a class 8 asset (there were no disposals). If the asset cost $20,000, had an estimated salvage value of $5,000, using the declining balance method with an allowable rate of 20%, the allowable CCA in the first and second years would be, respectively,

Carter Ltd. is considering purchasing a new machine which will increase its current capacity of 100,000 units by 20%. The new machine, which will be acquired on January 1 of year 1 costs $4,000,000. Carter will also incur installation costs of $400,000 which are eligible for capital cost allowance. The new machine will have a useful life of 5 years and an estimated residual value of $200,000. The current machine has an undepreciated capital cost equal to its salvage value as at January 1, year 1 of $200,000. Annual depreciation of $45,000 calculated on a straight line basis is being recorded. The applicable capital cost allowance rate for both machines is 30%. Budgeted unit cost data for Year 1 assuming an activity level of 90,000 units are as follows: Additional information is as follows: • Sales commissions are 15% of sales. • Variable and fixed manufacturing overheads are applied on the basis of machine hours. • The new machine is expected to reduce direct materials costs by 5% and direct labour costs by 20% • It is estimated unit sales will increase by 3,000 units/year for years 1 to 5 inclusive. • Inflation on selling prices and variable costs is predicted at 8%/year. • If the old machine is not replaced it will require maintenance expenses of $50,000 in year 2 and another $30,000 in the year 4. • The company requires a real return of 11% • The asset will be sold before year end of year 5 and therefore will not be eligible for CCA in year 5. Required: Should the new machine be purchased?

The Columbian Coffee Company is planning on purchasing a special coffee grinding machine that costs $30,000 and is in a CCA class with a 20% rate. The company has decided to use its traditional real rate of return of 10 percent as the required rate of return. It is anticipated the equipment will generate net savings in nominal before-tax dollars as follows: The anticipated salvage value of the equipment at the end of three years is $5,000 and is not taxable. The income tax rate of Columbian Coffee is 40 percent. What is the after-tax net present value of the investment?

What is the net present value of the investment, assuming the required rate of return is 24%? Would the company want to purchase the new machine?

Massey Corporation's nominal rate of return for capital-budgeting projects is 20%, which includes a 10% inflation rate. The present value of $1 at 20% for one year is 0.833. Assume a 40% marginal tax rate. Required: Calculate the after-tax present value (expressed in nominal dollars) of: a. Receiving inflation adjusted savings of $110,000 at the end of the first year; and, b. CCA of $70,000 to be deducted one year from now.

What is the net present value of the investment assuming a discount rate of 13%?

A project's net present value is increased if

A new machine will cost $500,000. It is in a CCA class pool that uses a declining balance rate of 30%. The company's tax rate is 40% and it requires a 15% rate of return on investments. Calculate the cash savings from the tax shield the first year assuming the savings occur at year end.

Bacon Jewelers are interested in buying a new stone-polishing machine for $25,000. The new machine will reduce stone polishing time substantially and annual operating costs are expected to be only $5,000. The current machine, with a fair market value of $10,000 and a book value of $15,000, has annual operating costs of $12,500. The current machine can be updated for a cost of $17,500. Because of advancing technology, neither the new machine nor the remodelled old machine is expected to last longer than four years. The new machine will have a salvage value after taxes of $500 but the remodelled machine will have a salvage value of zero. The company has a tax rate of 30 percent. For tax purposes, the equipment is class 8, which has a CCA rate of 20% . Required: Several categories of cash flows are common in capital budgeting analysis. Place as much information from this problem as possible into each one of the cash flow categories.

A company's General Ledger recorded sales of $545,000 last year, when the inflation rate adjusted for the year, was 4.0%. If the company's required rate of return was 10%, what are the real cash flows, and the nominal cash flows, respectively?

Melvin, Otto, and Clapman consulting firm is considering the purchase of a new telephone system for $10,000. It is believed that the new equipment will save $750 a year over current costs. Telephone equipment is included in Class 3 for tax purposes. Class 3 CCA rate is 5%. The new equipment has an estimated life of five years. Its salvage value is estimated at $400 at the end of five years. Required: What items must be considered in the analysis of the purchase?

If the nominal rate of interest is 16% and the inflation rate is 5%, the real rate of interest (rounded to the nearest tenth of a percent) is:

The nominal rate of return is the rate of return demanded to cover investment risk.

The division manager of Bagley Company asked her assistant to gather information for a new investment. She is impressed with all the information but is unsure about which investment to choose because they are of such different sizes. Since the investments are mutually exclusive, she can choose only one. As might be expected, she wants the one that will return the most for the money. The relevant information for each project is as follows. Required: Someone told the manager the profitability index helped to solve decisions when the other factors were confusing. What is the profitability index for each project?

Capital cost allowance is the income tax version of financial reporting depreciation.

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 the sales figures be for each month, respectively, assuming the owner uses a nominal rate approach?

Exar Construction Ltd is contemplating the purchase of new equipment. The equipment would cost $40,000, have an expected life of 8 years, and a zero terminal salvage value. The equipment would be Class 8 (20% CCA rate), and would generate $125,000 additional revenue annually, and Exar would incur additional annual expenses of $115,000 for labour and material. The company's marginal tax rate is 20%, and the required after-tax rate of return is 14%. Additional data (for interest rate of 14%, 8 periods): Required: Calculate the net after-tax present value, and determine whether Exar should purchase the equipment.

After-tax cash-operating flows are equal to

Businesses may opt not to claim the full amount of available capital cost allowance.