Question

Spherical Manufacturing recently spent $14 million to purchase some equipment used in the manufacture of disk brakes. This equipment has a CCA rate of 30% and Spherical's marginal corporate tax rate is 29% a. What are the annual CCA deductions associated with this equipment for the first five years? b. What are the annual CCA tax shields for the first five years? c. What is the present value of the first five CCA tax shields if the appropriate discount rate is 8% per year? d. What is the present value of all the CCA tax shields assuming the equiment is never sold and the appropriate discount rate is 8% per year? e. How might your answer to part (d) change if Spherical anticipates that its marginal corporate tax rate will increase substantially over the next five years?

Answer 1

Values in millions Start Book value CCA @ 30% End book value Tax shield 14.00 4.20 9.80 1.22 9.80 2.94 6.86 0.85 6.86 2.06 4.80 0.60 4.80 1.44 3.36 0.42 3.36 1.01 2.35 0.29 PV of tax shield @ 8% $2.84 The formula for CCA till infinite time is 14*.29/1.08*(1+.71/1.08 +(0.71/1.08)^2+...) PV = 14*.29/1.08 *1/(1-.71/1.08) PV = 10.97 If tax increases value of tax shields increases and hence PV increases