ALL ANSWERS SHOULD BE HANDWRITTEN Question 1 Assume ABC Corporation operates in the United States and uses straight line depreciation (instead of the CCA (Capital Cost Allowance) approach we use in Canada). It acquires equipment for $50,000 (there is no half year rule in the US) and will depreciate it in equal annual amounts over 5 years, after which the machinery will be worthless. ABC expects to produce and sell 100,000 units of its product per year using this equipment, at a selling price of $7.95 per unit. The product that the ABC manufactures on this equipment has variable costs equal to 70% of sales revenue and the fixed costs other than depreciation are $83,000/year. The corporate tax rate is 30%. The appropriate discount rate is 11%. a) What is the Net Present Value (NPV) of this equipment? (6 marks) b) What is the NPV breakeven point for this equipment? (3 marks) Question 2 The Table below shows Canadian industries that use small and large amounts of debt respectively. Explain why these industries choose the debt policies they do? Except possibly in the case of the mining industry, you should be able to find a rationale that applies to the whole group of 4 industries, and not have to explain each industry separately. Debt/Equity Ratios for Canadian Industries 2015 2016 2017 2018 2019 Low debt Repair, maintenance and personal services Professional, scientific and technical services Educational and healthcare services (private, non-gov't) Mining 0.73 0.86 0.722 0.547 0.829 0.56 0.78 0.674 0.72 0.653 0.81 0.508 0.77 0.564 0.681 0.503 0.693 0.73 0.656 0.673 1.699 1.57 1.593 1.565 1.477 High Debt Construction Motor vehicle and parts dealers Real estate Machinery and equipment rental and leasing 2.656 2.516 2.629 2.378 1.683 2.134 1.944 1.994 1.926 1.869 1.975 1.904 1.962 1.864 1.668 ALL ANSWERS SHOULD BE HANDWRITTEN Question 1 Assume ABC Corporation operates in the United States and uses straight line depreciation (instead of the CCA (Capital Cost Allowance) approach we use in Canada). It acquires equipment for $50,000 (there is no half year rule in the US) and will depreciate it in equal annual amounts over 5 years, after which the machinery will be worthless. ABC expects to produce and sell 100,000 units of its product per year using this equipment, at a selling price of $7.95 per unit. The product that the ABC manufactures on this equipment has variable costs equal to 70% of sales revenue and the fixed costs other than depreciation are $83,000/year. The corporate tax rate is 30%. The appropriate discount rate is 11%. a) What is the Net Present Value (NPV) of this equipment? (6 marks) b) What is the NPV breakeven point for this equipment? (3 marks) Question 2 The Table below shows Canadian industries that use small and large amounts of debt respectively. Explain why these industries choose the debt policies they do? Except possibly in the case of the mining industry, you should be able to find a rationale that applies to the whole group of 4 industries, and not have to explain each industry separately. Debt/Equity Ratios for Canadian Industries 2015 2016 2017 2018 2019 Low debt Repair, maintenance and personal services Professional, scientific and technical services Educational and healthcare services (private, non-gov't) Mining 0.73 0.86 0.722 0.547 0.829 0.56 0.78 0.674 0.72 0.653 0.81 0.508 0.77 0.564 0.681 0.503 0.693 0.73 0.656 0.673 1.699 1.57 1.593 1.565 1.477 High Debt Construction Motor vehicle and parts dealers Real estate Machinery and equipment rental and leasing 2.656 2.516 2.629 2.378 1.683 2.134 1.944 1.994 1.926 1.869 1.975 1.904 1.962 1.864 1.668
