Question

A proposed cost-saving device has an installed cost of $520,000. It is in Class 8 (CCA rate = 20%) for CCA purposes. It will actually function for five years, at which time it will have no value. There are no working capital consequences from the investment, and the tax rate is 35%.

a. What must the pre-tax cost savings be for us to favour the investment? We require an 10% return. (Hint: This one is a variation on the problem of setting a bid price.) (Do not round your intermediate calculations. Round the final answer to 2 decimal places. Omit $ sign in your response.)

Cost savings           $

b. Suppose the device will be worth $76,000 in salvage (before taxes). How does this change your answer? (Do not round your intermediate calculations. Round the final answer to 2 decimal places. Omit $ sign in your response.)

Cost savings           $

Answer 1

Solution:

CCA gives tax shields to varied assets under different classes. For an investment to be feasible with specific returns required and no salvage value, the present value of the CCA tax shield for the first year needs to be found.

Present Value of CCA Tax Shield for Year 1 = CdT/d+k *(1+0.5k/1+k)

            =$520,000*0.2*0.35/(0.2+0.10) * (1+0.5*0.10)/(1+0.10)

= 121,334 * 0.954546

= 115,819