Question

Consider the following investment opportunity: Initial investment: 25,000 Cash Flow Year 1:     3,000 Cash Flow Year...

Consider the following investment opportunity:

Initial investment: 25,000

Cash Flow Year 1:     3,000

Cash Flow Year 2:     8,000

Cash Flow Year 3:   13,000

Cash Flow Year 4:     5,000

Cash Flow Year 5:     3,000

What is the CCA deduction (or expense) for year 2?

And the CCA tax shield for year 4?

The asset belongs to an asset class with a CCA depreciation rate of 25%. The company’s tax rate is 30%

Part A

CCA deduction for year 2 is the beginning value of the initial investment at year 2 * CCA depreciation rate.

The beginning value of the initial investment in year 2 is the beginning value of the initial investment at year 1 - CCA depreciation rate.
The beginning value of the initial investment at year 1= 25,000
CCA rate = 25%
Ending value of investment = 18,750

The beginning value of the initial investment at year 2 = 18,750
CCA rate = 25%
Therefore, CCA deduction for year 2 is 18,750 * 25% = 4687.5

Part B

Tax shield for year 4 = CCA expense * tax rate

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