Matty's Place is considering the installation of a new computer system that will cut annual operating costs by $11,001. The system will cost $48,000 to purchase and install. This system will belong in a
40% CCA class. What is the amount of the increase in earnings before interest and taxes in the ﬁrst
Year for this project?

Question

Quizplus · Accepted Answer

To calculate the increase in earnings before interest and taxes (EBIT) in the first year, we need to determine the tax savings and the depreciation expense associated with the new computer system.

Tax savings: 
Annual operating cost savings = $11,001 
Tax savings = Tax rate x annual operating cost savings

Assuming a tax rate of 30%, tax savings = 0.3 x $11,001 = $3,300

Depreciation expense: 
The computer system belongs in a 40% CCA class, which means that the annual depreciation rate is 40%. 
Depreciation expense = 40% x $48,000 = $19,200

Increase in EBIT: 
Increase in EBIT = tax savings + depreciation expense 
Increase in EBIT = $3,300 + $19,200 = $22,500

However, we must also factor in the initial cost of $48,000, which will reduce the overall increase in earnings. 
Therefore, the net increase in earnings before interest and taxes in the first year is: 
Net increase in EBIT = Increase in EBIT - Cost 
Net increase in EBIT = $22,500 - $48,000 
Net increase in EBIT = -$25,500

This means that the company will actually experience a decrease in earnings before interest and taxes in the first year because the cost of the new computer system outweighs the tax savings and depreciation expense.

Of the answer choices given, the closest option is C: $1,400. However, this is not the correct answer as it implies an increase in earnings before interest and taxes, whereas the actual result is a decrease.

Matty's Place Is Considering the Installation of a New Computer