Dee's Forest Service Supplies is looking to expand its business. The new business is expected to generate $2.75 million per year in sales over the next 5 years. Annual costs would increase by $2.5 million. An investment in working capital of $90,000 would have to be made initially. The machinery (CCA rate of 30%) would cost $550,000, with additional costs of $45,000 to be incurred for setup and training. They also estimate that it would be possible to sell the equipment for 20% of its initial value at the end of 5 years. The company would set up operations in a building it does not use but currently rents out for $70,000 per year. If the firm's cost of capital is 13% and its marginal tax rate is 35%, should it proceed with this new business? 12 marks 13% Summary Tax Rate 35% Initial Investment $ (685,000) PV of Cash Flows After Tax Equipment cost $ 550,000 PV of CCA Tax Shield Setup and training 45,000 PV of Ending Cash Flows Investment in NWC 90,000 NPV A. Initial Investment $ 685,000 Proceed with Project? Yr 2 3 4 5 Sales 2,750,000 Less forgone rental Income 70,000 Costs 2,500,000 Project cash flows before tax 180,000 Tax 63,000 Project cash flows after tax 117,000 B. PV of Cash Flows After Tax C. PV of CCA tax shield formula Salvage value (if asset class remains open after asset is sold) Return of NW C Total ending cashflow CdT 1+0.5r SaTY 1 D. PV of ending cash flows PV= r+d (r+d) (1+r)" Why are interest and sunk costs not included but opportunity costs and externalities are included in the NPV approach to project analysis? C = Capital Cost 2 marks d = CCA rate for asset class T = Corporate tax rate r = cost of capital rate