6. Glowachuk Industries Ltd. is considering an investment in new equipment. The equipment has a cost of $2,000,000, will be depreciated for tax purposes at a CCA rate of 25%, and is expected to have a salvage value of $150,000 at the end of 6 years. The asset would be sold in year 7. The machine currently in use was purchased for $1,000,000 and has a net book value of $250,000. It would be sold for $50,000 immediately if the new equipment was purchased, resulting in a loss of $200,000 This equipment is more efficient and is expected to increase production, resulting in an increase in annual cash revenues of $600,000. Variable operating costs per unit are expected to decline, but with the increase in volume, there is an expected net increase to cash operating expenses of $120,000 annually. Working capital is expected to increase by $90,000 when the equipment is acquired, and recovered at the end of year six. Glowachuk pays income tax at a rate of 20% has an after-tax cost of capital of 8% Required: a) Calculate the tax shield on the investment in new equipment. b) Calculate the value of the lost tax shield on the disposition of equipment that should be taken into consideration when evaluating whether or not to acquire the new equipment c) Calculate the value of the working capital recovery that should be taken into consideration when evaluating whether or not to acquire the new equipment 1 Focus 2 d) Explain why the net present value method is superior to the payback period method for determining whether or not to invest in a capital project. 6. Glowachuk Industries Ltd. is considering an investment in new equipment. The equipment has a cost of $2,000,000, will be depreciated for tax purposes at a CCA rate of 25%, and is expected to have a salvage value of $150,000 at the end of 6 years. The asset would be sold in year 7. The machine currently in use was purchased for $1,000,000 and has a net book value of $250,000. It would be sold for $50,000 immediately if the new equipment was purchased, resulting in a loss of $200,000 This equipment is more efficient and is expected to increase production, resulting in an increase in annual cash revenues of $600,000. Variable operating costs per unit are expected to decline, but with the increase in volume, there is an expected net increase to cash operating expenses of $120,000 annually. Working capital is expected to increase by $90,000 when the equipment is acquired, and recovered at the end of year six. Glowachuk pays income tax at a rate of 20% has an after-tax cost of capital of 8% Required: a) Calculate the tax shield on the investment in new equipment. b) Calculate the value of the lost tax shield on the disposition of equipment that should be taken into consideration when evaluating whether or not to acquire the new equipment c) Calculate the value of the working capital recovery that should be taken into consideration when evaluating whether or not to acquire the new equipment 1 Focus 2 d) Explain why the net present value method is superior to the payback period method for determining whether or not to invest in a capital project