An officer for a large construction company is feeling nervous. The anxiety is c
ID: 2615039 • Letter: A
Question
An officer for a large construction company is feeling nervous. The anxiety is caused by a new excavator just released onto the market. The new excavator makes the one purchased by the company a year ago obsolete. As a result, the market value for the company’s excavator has dropped significantly, from $600,000 a year ago to $50,000 now. In 10 years, it would be worth only $3,000. The new excavator costs only $950,000 and would increase operating revenues by $90,000 annually. The new equipment has a 10-year life and expected salvage value of $175,000. The tax rate is 35 percent, the CCA rate, 25 percent for both excavators, and the required rate of return for the company is 14 percent. What is the NPV of the new ex
Explanation / Answer
Calculation of NPV of new excavator Year 0 1 2 3 4 5 6 7 8 9 10 NPV Cost of new excavator -$950,000 After tax salvage value of old excavator $190,000 Increase in operating revenue $90,000 $90,000 $90,000 $90,000 $90,000 $90,000 $90,000 $90,000 $90,000 $90,000 Tax @ 35% on operating revenue -$31,500 -$31,500 -$31,500 -$31,500 -$31,500 -$31,500 -$31,500 -$31,500 -$31,500 -$31,500 Depreciation tax shield $83,125 $62,344 $46,758 $35,068 $26,301 $19,726 $14,794 $11,096 $8,322 $6,241 After tax salvage value of new excavator $132,474 Net Cash flow -$760,000 $141,625 $120,844 $105,258 $93,568 $84,801 $78,226 $73,294 $69,596 $66,822 $197,216 x Discount Factor @ 14% 1.00000 0.87719 0.76947 0.67497 0.59208 0.51937 0.45559 0.39964 0.35056 0.30751 0.26974 Present Value -$760,000 $124,232 $92,985 $71,046 $55,400 $44,043 $35,639 $29,291 $24,397 $20,548 $53,198 -$209,220 NPV of new Excavator = -$209,220 After tax salvage value of old excavator Sale Value 50000 Less : Book value at the end of 1st Year [$600000 - $150000] 450000 Loss on sale -400000 Tax shield on Loss @ 35% 140000 After tax salvage value of old excavator 190000 Calculation of depreciation tax shield on new excavator Year Beginning Book Value CCA rate Depreciation Depreciation Tax shield @ 35% 1 950,000.00 25% 237,500.00 83,125.00 2 712,500.00 25% 178,125.00 62,343.75 3 534,375.00 25% 133,593.75 46,757.81 4 400,781.25 25% 100,195.31 35,068.36 5 300,585.94 25% 75,146.48 26,301.27 6 225,439.45 25% 56,359.86 19,725.95 7 169,079.59 25% 42,269.90 14,794.46 8 126,809.69 25% 31,702.42 11,095.85 9 95,107.27 25% 23,776.82 8,321.89 10 71,330.45 25% 17,832.61 6,241.41 Total Accumulated depreciation 896,502.16 Calculation of after tax salvage value of new excavator Sale Value 175,000.00 Less : Book value at the end of 10th year 53,497.84 Profit on sale 121,502.16 Tax @ 35% 42,525.76 After tax salvage value of new excavator 132,474.24