ch13-AFM102s2012

Assumes an infinite stream of cca deductions

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Unformatted text preview: nt would be sold for its salvage value (which will be very little, and thus estimated to be zero). Holland Company uses a 20% rate, assuming no salvage value, to compute CCA deductions for tax purposes. More information is provided on the next slide. Managerial Accounting 13-68 Holland Company – An Example Cost of equipment W orking capital needed Estimated annual cash receipts from ore sales Estimated annual cash e xpenses for mining ore Cost of road repairs needed in 6 years Salvage value of the e quipment in 10 years After-tax cost of capital Tax rate Managerial Accounting $ $ $ 300,000 75,000 250,000 $ 170,000 $ 40,000 $ 12% 30% Should Should Holland open a mine on the property? the 13-69 Holland Company – An Example Step One: Compute the net annual cash receipts from operating the mine. receipts Cash receipts from ore sales Less cash expenses for mining ore Net cash receipts Managerial Accounting $ $ 250,000 170,000 80,000 13-70 Holland Company – An Example Step Two: Identify all relevant cash flows Step as shown. as Holland Company (1) (2) Items and Computations Cost of new equipment W orking capital needed Net annual cash receipts Road repairs Salvage value of equipment Release of working capital Present value of CCA tax shield Net present value Managerial Accounting Year Amount Now $ (300,000) Now $ (75,000) 1-10 $ 80,000 6 $ (40,000) 10 $ 10 $ 75,000 13-71 Holland Company – An Example Step Three: Translate the relevant cash Step flows to after-tax cash flows as shown. flows Items and Computations Cost of new equipment Working capital needed Net annual cash receipts Road repairs Salvage value of equipment Release of working capital Present value of CCA tax shield Net present value Managerial Accounting Holland Company (1) (2) (3) Tax Effect Year Amount (1) × (2) Now $ (300,000) – Now $ (75,000) – 1-10 $ 80,000 1-.30 6 $ (40,000) 1-.30 10 $ – 10 $ 75,000 – (4) After-Tax Cash Flows $ (300,000) $ (75,000) $ 56,000 $ (28,000) $ $ 75,000 13-72 CCA Instead of Depreciation • Capital cost allowance (CCA) is essentially depreciation for tax purposes • For each income tax year, the tax shield on CCA = CCA tax deduction × tax rate • CCA is calculated on a declining balance basis. Each year’s CCA is calculated as: • Undepreciated Capital Cost (UCC) × CCA rate • In the year an asset is purchased, only one-half of the prescribed rate is permitted to be deducted. Managerial Accounting 13-73 Present Value of CCA Tax Shields The present value of this perpetual stream of tax savings from a declining balance CCA is calculated by using the CCA tax shield formula: PV = [(Cdt)/(d + k)] × [(1 + 0.5k)/(1 + k)] Where: c = capital cost of the asset added to the asset pool; d = CCA rate; t = marginal income tax rate; k = cost of capital. In the case of Holland Company: PV = [(Cdt)/(d + k)] × [(1 + 0.5k)/(1 + k)] PV = [($300,000×0.2×0.3)/(0.2+0.12)] × [(1 + 0.5×0.12)/(1+0.12)] PV = [$18,000/0.32] × [1.06/1.12] PV = $56,250 × 0.946429 PV = $53,237 Managerial Accounting 13-74 Holland Company – An Example Step Four: Discount all cash flows to Step their present value as shown. their Items and Computations Cost of new equipment Working capital needed Net annual cash receipts Road repairs Salvage value of equipment Release of working capital Present value of CCA tax shield Net present value Managerial Accounting Holland Company (1) (2) (3) Tax Effect Year Amount (1) × (2) Now $ (300,000) – Now $ (75,000) – 1-10 $ 80,000 1-.30 6 $ (40,000) 1-.30 10 $ – 10 $ 75,000 – (4) (5) After-Tax 12% Cash Flows Factor $ (300,000) 1.000 $ (75,000) 1.000 $ 56,000 5.650 $ (28,000) 0.507 $ 0.322 $ 75,000 0.322 (6) Present V alue $ (300,000) (75,000) 316,400 (14,196) 24,150 (48,646) 53,237 $ 4,591 13-75 End of Chapter 13 Managerial Accounting...
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This note was uploaded on 09/30/2013 for the course AFM 102 taught by Professor R.ducharme during the Spring '09 term at Waterloo.

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