Tough Outdoor Supplies is looking to expand its business. The new business is expected to generate $2.7 million per year in sales over the next 5 years. Annual costs would increase by $2.2 million. Both sales revenues and costs are expected to increase by 2% per year due to inflation. An investment in working capital of $65,000 would have to be made initially. The machinery (CCA rate of 30%) would cost $645,000, with additional costs of $25,000 to be incurred for setup and training. They also estimate that it would be possible to sell the equipment for 15% 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 $80,000 per year. If the firm's cost of capital is 7% and its tax rate is 35%, should it proceed with this new business? Investment outlay (Operating (NOWC cash flow Salvage cash flow "cash flow 7% 35% Summary Tax Rate Initial Investment $ 735,000 Equipment cost Setup and training Investment in NWC A. Initial Investment 645,000 25,000 65,000 735,000 PV of Cash Flows After Tax PV of CCA Tax Shield PV of Ending Cash Flows NPV Proceed with Proiject? Why Yr 2 3 4 Sales Less forgonerental Income Project cash flows before tax Tax Project cash flows after tax B. PV of Cash Flows After Tax C. PV of CCA tax shield formula if asset class remains open after asset is sold) Salvage value Return of NWC Total ending cashflow PV of ending cash flows PV = 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 d = CCA rate for asset class T = Corporate tax rate cost of capital rate S = Salvage value of asset 7% 30% 7% # years 5 164,340 C. PV of CCA Tax Shield Tough Outdoor Supplies is looking to expand its business. The new business is expected to generate $2.7 million per year in sales over the next 5 years. Annual costs would increase by $2.2 million. Both sales revenues and costs are expected to increase by 2% per year due to inflation. An investment in working capital of $65,000 would have to be made initially. The machinery (CCA rate of 30%) would cost $645,000, with additional costs of $25,000 to be incurred for setup and training. They also estimate that it would be possible to sell the equipment for 15% 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 $80,000 per year. If the firm's cost of capital is 7% and its tax rate is 35%, should it proceed with this new business? Investment outlay (Operating (NOWC cash flow Salvage cash flow "cash flow 7% 35% Summary Tax Rate Initial Investment $ 735,000 Equipment cost Setup and training Investment in NWC A. Initial Investment 645,000 25,000 65,000 735,000 PV of Cash Flows After Tax PV of CCA Tax Shield PV of Ending Cash Flows NPV Proceed with Proiject? Why Yr 2 3 4 Sales Less forgonerental Income Project cash flows before tax Tax Project cash flows after tax B. PV of Cash Flows After Tax C. PV of CCA tax shield formula if asset class remains open after asset is sold) Salvage value Return of NWC Total ending cashflow PV of ending cash flows PV = 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 d = CCA rate for asset class T = Corporate tax rate cost of capital rate S = Salvage value of asset 7% 30% 7% # years 5 164,340 C. PV of CCA Tax Shield