Question

New equipment that has a five-year life costs $40,000. Freight is $1,000 and site preparation costs are $5,000. Both the freight and site preparation cost occur at t=0. The equipment will be added to the firm’s class 39 assets, CCA rate 25%. After tax cash flows are $23,000 per year for each of five years, and cash outflows are $6,000 per year. At the end of five years, the equipment can be sold for $10,000, less $2,000 in dismantling cost. The firms’ tax rate is 46%, and its opportunity cost of capital is 15%. Should the equipment be acquired?

Answer 1

Cost of equipment	40000
Freight	1000
Site Preparation Cost	5000
Depreciation	25%
After Tax Cash Flow per Year	23000
After Tax Cash Flow for 5 years	115000
Cash Outflows for 5 years	30000
Salvage value minus dismantling cost	8000
Tax Rate	46%
Opportunity cost of capital	15%

Total cost
Cost of equipment	40000
Freight	1000
Site Preparation Cost	5000
Cash Outflows for 5 years	30000
Interest forgone on these costs of equipment and freight and site prep (Appendix 1)	46522.43
Interest forgone on cash outflow (Appendix 2)	10454.29
Total	132976.7

Appendix 1

	Capital at beginning of year	% Interest	Interest	Capital at the end of year
1st Year	46000	0.15	6900	52900
2nd	52900	0.15	7935	60835
3rd	60835	0.15	9125.25	69960.25
4th	69960.25	0.15	10494.04	80454.29
5th	80454.29	0.15	12068.14	92522.43
Total			46522.43

Appendix 2

	Capital at beginning of year	% Interest	Interest	Capital at the end of year
2nd	6000	0.15	900	6900
3rd	12900	0.15	1935	14835
4th	20835	0.15	3125.25	23960.25
5th	29960.25	0.15	4494.038	34454.29
Total			10454.29

Total Benefit
After Tax Cash Flow for 5 years	115000
Interest earned on these cash flows	40074.77
Salvage value minus dismantling cost	8000
Total	163074.8

Appendix 3

	Capital at beginning of year	% Interest	Interest	Capital at the end of year
2nd	23000	0.15	3450	26450
3rd	49450	0.15	7417.5	56867.5
4th	79867.5	0.15	11980.13	91847.63
5th	114847.6	0.15	17227.14	132074.8
Total			40074.77

Tax rate is ignored as cash inflow are given after tax and it is assumed that tax is chargeable only on cash inflows.Also, since salvage value is given, depreciation is already adjusted there. No interest will be earned on the salvage value as it is sold after 5 years.

Since, the benefit is more than the cost, equipment should be acquired.