Question

A proposed cost-saving device has an installed cost of $640,000. 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 $92,000 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.)

Answer 1

a) The depreciation shall be 20% on declining balance basis and in the final year, all the remaining equipment cost will be depreciated. The tax shield for different years is as calculated below:

Year	0	1	2	3	4	5
Depreciation		128000	102400	81920	65536	262144
Tax shield		44800	35840	28672	22937.6	91750.4

Present value of cost savings due to depreciation tax shield

=44800/1.1+35840/1.1^2+28672/1.1^3+22937.6/1.1^4+91750.40/1.1^5

=$164525.27

b) In case Salvage value is $92000 , calculations are as shown below :

Year	0	1	2	3	4	5
Depreciation		128000	102400	81920	65536	170144
Tax shield		44800.00	35840.00	28672.00	22937.60	59550.40

Present value of cost savings due to depreciation tax shield

=44800/1.1+35840/1.1^2+28672/1.1^3+22937.6/1.1^4+59550.4/1.1^5

=$144531.61