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6. FIN 301-F10 Lab 6 Capital Budgeting PART II

# 6. FIN 301-F10 Lab 6 Capital Budgeting PART II - Capital...

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Capital Budgeting Continued… Session goals: Review of  CCA and EAC Exercises

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PV of CCA Tax Shield Formula Where: I 0  = Total Capital Investment d = CCA tax rate Tc = Corporate Tax Rate r = discount rate RS T  = Salvage value in year T T = number of periods in the project How to derive this formula??? ( 29 + × × × + - + × + × + × × = d r T d RS r r r d r T d I PV C T T C 1 1 1 5 . 0 1 0
Example: Depreciation and Salvage You purchase equipment for  \$100,000  and  it costs  \$10,000  to have it delivered and  installed. Based on past information, you  believe that you can sell the equipment for  \$17,000  when you are done with it  in 6  years . The company’s  marginal tax rate  is  40% .  If the applicable  CCA rate  is  20%   and the required return on this project is  10% , what is the present value of the CCA  tax shield?

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Example: Depreciation and Salvage continued The delivery and installation costs are  capitalized  in the cost of the equipment 25,441.05 ) 10 . 0 1 ( 1 10 . 0 20 . 0 40 . 0 20 . 0 000 , 17 10 . 0 1 10 . 0 5 . 0 1 10 . 0 0.20 40 . 0 0.20 110,000 CCA on shield tax PV 6 = + × + × × - + × + × + × × =
Example: Replacement Problem Original Machine Initial cost = 100,000 CCA rate = 20% Purchased 5 years ago Salvage today =  65,000 Salvage in  5 years  =  10,000 New Machine Initial cost = 150,000 5-year life Salvage in 5 years = 0 Cost savings  =  50,000 per year CCA rate = 20% Required return =  10% Tax rate = 40% 5

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Remember that we are interested in  incremental  cash flows If we buy the new machine, then we will  sell the old machine What are the cash flow consequences of  selling the old machine today instead of in  5 years? 6
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6. FIN 301-F10 Lab 6 Capital Budgeting PART II - Capital...

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