New equipment costs $700,000 and is expected to last for four years with no salvage value. During this time the company will use a 30% CCA rate. The new equipment will save $550,000 annually before taxes. If the company's required rate of return is 15%, determine the NPV of the purchase. Assume a tax rate of 35%.

Question

Quizplus · Accepted Answer

The NPV of the purchase can be calculated by considering the initial investment, the annual savings after taxes, and the depreciation tax shield. The initial investment is $700,000. The annual savings after taxes are $550,000 * (1 - 0.35) = $357,500. The depreciation tax shield is calculated using the CCA rate of 30% on a declining balance, which provides a tax shield of CCA rate * tax rate * book value at the beginning of each year. The NPV can be calculated using these values and discounting at the company's required rate of return of 15%. The correct NPV, given the information, is $473,336, which accounts for the initial investment, the net savings after taxes, and the benefit from the depreciation tax shield over the equipment's life.

New Equipment Costs $700,000 and Is Expected to Last for Four