Question

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Spherical Manufacturing recently spent $10 million to purchase some equipment used in the manufacture of disk drives. This equipment has a CCA rate of 30% and Spherical's marginal corporate tax rate is 35%. a. What are the annual CCA deductions associated with this equipment for the first five years? b. What are the annual CCA tax shields for the first five years? c. What is the present value of the first five CCA tax shields if the appropriate discount rate is 12% per year? d. What is the present value of all the CCA tax shields assuming the equiment is never sold and the appropriate discount rate is 12% per year? e. How might your answer to part (d) change if Spherical anticipates that its marginal corporate tax rate will increase substantially over the next five years? a. What are the annual CCA deductions associated with this equipment for the first five years? The CCA deduction for year 1 is $ . (Round to the nearest dollar.)

Answer 1

a. Annual CCA deductions

CCA Deduction = Opening book value * CCA rate

Year	Opening Book value	CCA Deduction	Closing book value
1	10000000	3000000	7000000
2	7000000	2100000	4900000
3	4900000	1470000	3430000
4	3430000	1029000	2401000
5	2401000	720300	1680700

b. Annual CCA tax shield

Year	CCA Deduction	Tax Shield @ 35%
1	3000000	1050000
2	2100000	735000
3	1470000	514500
4	1029000	360150
5	720300	252105

c. PV of CCA tax shields

Year	CCA Deduction	Tax Shield @ 35%	DF @ 12%	Present value
1	3000000	1050000	0.893	937500.00
2	2100000	735000	0.797	585937.50
3	1470000	514500	0.712	366210.94
4	1029000	360150	0.636	228881.84
5	720300	252105	0.567	143051.15
Total Present Value				2261581.42

d. PV of CCA tax shields till perpetuity

PV = [ Equipment cost * Tax Rate * CCA rate * ( 1 + rate of return/2 ) ] / [(Rate of return + CCA Rate) * ( 1 + Rate of return)]

= [10000000 * 35% * 30% * (1 + 0.12/2)] / (0.12 + 0.30) * (1 + 0.12)

= [1050000 * (1.06)] / (0.42 * 1.12)

= 1113000 / 0.47

= 2368085

Note: As per HOMEWORKLIB POLICY, when there are multiple sub questions, the first 4 should be answered.