Cameron, Inc. is contemplating the acquisition of some new equipment. The purchase price is $66,000. Assume that the CCA for works out to be 33.33 percent, 44.44 percent, 14.82 percent,
And 7.41 percent of the value over years 1 to 4, respectively. The equipment will be worthless at the
End of that time. The equipment can be leased for $18,000 a year. The ﬁrm can borrow money at
8)5 percent and has a 34 percent tax rate. What is the amount of the CCA tax shield in year 4?
A) $525.27
B) $1,624.50
C) $1,662.80
D) $3,829.60
E) $4,890.60

Question

Quizplus · Accepted Answer

First, we need to calculate the CCA tax shield for each year:

- Year 1: $66,000 * 33.33% = $22,000
- Year 2: ($66,000 - $22,000) * 44.44% = $19,506.40
- Year 3: ($66,000 - $22,000 - $19,506.40) * 14.82% = $4,678.08
- Year 4: ($66,000 - $22,000 - $19,506.40 - $4,678.08) * 7.41% = $1,478.64

The total CCA tax shield over four years is $47,663.12.

Next, let's calculate the present value of the tax shield:

PV = $22,000/(1 + 0.85) + $19,506.40/(1 + 0.85)^2 + $4,678.08/(1 + 0.85)^3 + $1,478.64/(1 + 0.85)^4
PV = $33,983.82

The after-tax cost of leasing the equipment for four years is:

After-tax leasing cost = $18,000 * (1 - 0.34) * 4 = $47,520

Finally, let's calculate the after-tax cost of borrowing to purchase the equipment:

After-tax cost of borrowing = $66,000 * 0.085 * (1 - 0.34) = $3,978

Comparing the after-tax cost of leasing and the after-tax cost of borrowing, we can see that it is cheaper to purchase the equipment using financing. The total after-tax cost of purchase is:

After-tax cost of purchase = $66,000 + $3,978 - $33,983.82 = $35,994.18

Therefore, the best choice is to purchase the equipment using financing.