G. Esteban, the president of a Toronto
trucking company, is considering whether to invest $410,000 in new semiautomatic
loading equipment that will last five years, have zero scrap value, and generate
cash operating savings in labour usage of $160,000 annually, using 2006
prices and wage rates. It is December 31, 2006.
The minimum desired rate of return is 18 percent per year after taxes.
1. Compute the net present value of the project. Assume a 40 percent tax
rate and that the truck qualifies for Class 10, 30 percent declining balance
for tax purposes.
2. Esteban is wondering if the model in requirement 1 provides a correct
analysis of the effects of inflation. She maintains that the 18 percent
rate embodies an element attributable to anticipated inflation. For purposes
of this analysis, she assumes that the existing rate of inflation,
10 percent annually, will persist over the next five years. Repeat
requirement 1, adjusting the cash operating savings upward by using
the 10 percent inflation rate.
3. Which analysis, the one in requirement 1 or 2, is correct? Why?