Never-Wet Outdoor Suppliesis looking to expand its business. The new business is
ID: 2614806 • Letter: N
Question
Never-Wet Outdoor Suppliesis looking to expand its business. The new business is expected to generate $2.7 million per year in sales over the next 5 years. Annual costs would increase by $2.2 million. An investment in working capital of $70,000 would have to be made initially. The machinery (CCA rate of 30%) would cost $650,000, with additional costs of $30,000 to be incurred for setup and training. They also estimate that it would be possible to sell the equipment for 15% of its initial value at the end of 5 years. The company would set up operations in a building it does not use but currently rents out for $80,000 per year. If the firm's cost of capital is 8% and its tax rate is 30%, should it proceed with this new business?
r= 8% Summary Tax Rate 30% Initial Investment PV of Cash Flows After Tax Equipment cost PV of CCA Tax Shield Setup and training PV of Ending Cash Flows Decision: Investment in NWC NPV A. Initial Investment Proceed with Project? Yr 1 2 3 4 5 Sales Less forgone rental Income Costs Project cash flows before tax Tax Project cash flows after tax B. PV of Cash Flows After Tax C. PV of CCA tax shield formula Salvage value (if asset class remains open after asset is sold) Return of NW C Total ending cashflow D. PV of ending cash flows C = Capital Cost $680,000 d = CCA rate for asset class 30% T = Corporate tax rate 30% r = cost of capital rate 8% S = Salvage value of asset $97,500 n=# years 5 C. PV of CCA Tax Shield 139,372Explanation / Answer
r=
8%
Summary
Tax Rate
30%
Initial Investment
-0.75
PV of Cash Flows After Tax
$1.17
Equipment cost
650000
PV of CCA Tax Shield
0.139372
Setup and training
30000
PV of Ending Cash Flows
0.09027778
Decision:
Proceed with the business because the NPV is positive
Investment in NWC
70000
NPV
0.65350653
A. Initial Investment
750000
Proceed with Project?
Yes
Yr
1
2
3
4
5
Sales
2.7
2.7
2.7
2.7
2.7
Less forgone rental Income
-0.08
-0.08
-0.08
-0.08
-0.08
Costs
-2.2
-2.2
-2.2
-2.2
-2.2
Project cash flows before tax
0.42
0.42
0.42
0.42
0.42
Tax
0.126
0.126
0.126
0.126
0.126
Project cash flows after tax
0.294
0.294
0.294
0.294
0.294
B. PV of Cash Flows After Tax
$1.17
C. PV of CCA tax shield formula
Salvage value
97500
(if asset class remains open after asset is sold)
Return of NW C
0
Total ending cashflow
97500
D. PV of ending cash flows
90,277.78
C = Capital Cost
$680,000
d = CCA rate for asset class
30%
T = Corporate tax rate
30%
r = cost of capital rate
8%
S = Salvage value of asset
$97,500
n=# years
5
C. PV of CCA Tax Shield
139,372
r=
8%
Summary
Tax Rate
30%
Initial Investment
-0.75
PV of Cash Flows After Tax
$1.17
Equipment cost
650000
PV of CCA Tax Shield
0.139372
Setup and training
30000
PV of Ending Cash Flows
0.09027778
Decision:
Proceed with the business because the NPV is positive
Investment in NWC
70000
NPV
0.65350653
A. Initial Investment
750000
Proceed with Project?
Yes
Yr
1
2
3
4
5
Sales
2.7
2.7
2.7
2.7
2.7
Less forgone rental Income
-0.08
-0.08
-0.08
-0.08
-0.08
Costs
-2.2
-2.2
-2.2
-2.2
-2.2
Project cash flows before tax
0.42
0.42
0.42
0.42
0.42
Tax
0.126
0.126
0.126
0.126
0.126
Project cash flows after tax
0.294
0.294
0.294
0.294
0.294
B. PV of Cash Flows After Tax
$1.17
C. PV of CCA tax shield formula
Salvage value
97500
(if asset class remains open after asset is sold)
Return of NW C
0
Total ending cashflow
97500
D. PV of ending cash flows
90,277.78
C = Capital Cost
$680,000
d = CCA rate for asset class
30%
T = Corporate tax rate
30%
r = cost of capital rate
8%
S = Salvage value of asset
$97,500
n=# years
5
C. PV of CCA Tax Shield
139,372
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