Question

Bedford Company Ltd. operates a commercial fleet of fishing vessels off the south shore of Nova Scotia. Bedford is considering a proposal to do some of its routine maintenance work itself rather than contracting out all of its maintenance. The proposal will require Bedford to buy a $300,000 machine that will be depreciated over its three-year useful life on a straightline basis to a market salvage value of $50,000. Bedford will also need to make an initial investment in additional inventory of $75,000. The proposal is expected to result in pre-tax savings to the company of $200,000 per year. Bedford’s tax rate is 20%, its cost of capital is 16% and the applicable CCA rate on the machine is 25%. Based on this information, what is the NPV of the asset that would indicate that Bedford should accept the proposal? a) $46,531 b) $94,580 c) $102,392 d) $184,416

Answer 1

Cost	300,000
Useful life ( years)	3
Salvage value	50,000
Initial investment in additional inventory	75,000
Pre tax profit	200,000
tax rate	20%
cost of capital	16%
CCA rate of machine	25%
Depreciation per annum	83,333
Note :- it assume that profit before tax is profit before depreciation and tax
		Amount ($)
		Yrs1	Yrs2	yrs3	Total
Earning before tax and depreciation		200,000	200,000	200,000	600,000
Less :- Depreciation		83,333	83,333	83,333	250,000
Earning before tax		116,667	116,667	116,667	350,000
Less :- Tax @25%		29,167	29,167	29,167	87,500
Earning after tax		87,500	87,500	87,500	262,500
Add :- Depreciation		83,333	83,333	83,333	250,000
Net cash flow		170,833	170,833	170,833	512,500
Cost of capital @16%		0.862	0.743	0.641
Present value		147,258	126,929	109,504	383,692
Salvage value					32,050
Less :- Initial Investment					(75,000)
Less :- PV of machine cost $300000*0.641					(300,000)
NPV					40,742