2. Example on Replacing an Asset Assume XYZ inc. is considering buying a new equipment for $200,000 in order to replace an existing equipment which was bought 4 years ago for $150,000 and is expected to last for 6 more years. This existing equipment is worth only $50,000 if sold today due to rapid technological advances. The new equipment is expected to save $75,000 per year in production costs over its projected 6-year life through reduced wastage and downtime on the shop floor. If they keep current equipment for the rest of its working life, they can expect to realize $10,000 in scrap value in six years. The new equipment, on the other hand, saleable in the second-hand market and is expected to have a salvage value of $30,000 after 6 years. CCA rate is 20%, tax rate is 44% & discount rate is 15% Initial investment 0 1 2 Years 3 4 5 6 -200,000 50,000 Sale of old equip Opportunity cost (Salvage forgone) salvage value Capital Spending -10,000 30,000 -150,000 0 0 0 0 0 20,000 Operating savings -Taxes After tax 75,000 -33,000 42,000 75,000 75,000 75,000 75,000 75,000 -33,000 -33,000 42,000 42,000 -33,000 -33,000 -33,000 42,000 42,000 42,000 [IdTc] PV tax shield on CCA = d+r [1 +1.5r] 1+r Snd Tc d+r 1 I: net investment (1+r)" PV = 150,000(.20)(.44) 20+.15 1 +1.5(.15) 1+.15 PVA 20,000(.20)(.44) 1 =37,999.9 .20+.15 (1+.15)6 S: net salvage I = Total capital investment in the asset d=CCA rate for the asset class Tc Company's marginal tax rate r Discount rate S PV CCATS M Salvage or disposal value of the asse Asset life in years NPV=-150,000+ 42,000 [1 1 15% (1+15%)6 1 + 20,000 + 37,999.9 = 55,594.75 (1+15%)6 Dr. Iman Elmarashly +ve, then replace the old equip. The University of British Columbia | Sauder School of Business | COMM 421 Do not reproduce or post online without permission 18