Laurentide Resort Corporation is considering a seven-year project that requires an initial investment of $525,000 and generates annual after-tax operating cash flow of $225,000.The asset has a CCA rate of 30% and an expected salvage value of $65,000 at the end of the projects life.The firm's marginal tax rate is 40%.What is the tax savings from CCA in year 5 assuming half-year rule is applicable for CCA in year 1?

Question

Quizplus · Accepted Answer

First, we need to calculate the depreciation base:

Depreciation Base = Initial Investment - Salvage Value 
Depreciation Base = $525,000 - $65,000 = $460,000

Since the half-year rule applies to year 1, we'll calculate the CCA for that year separately:

CCA (Year 1) = Depreciation Rate * (1/2) * Depreciation Base 
CCA (Year 1) = 30% * (1/2) * $460,000 
CCA (Year 1) = $69,000

For the remaining years, we just need to apply the straight-line depreciation rate (since it's not specified otherwise in the question):

Annual CCA (Years 2-7) = Depreciation Rate * Depreciation Base 
Annual CCA (Years 2-7) = 30% * $460,000 = $138,000

So the total CCA over the 7-year project is:

Total CCA = CCA (Year 1) + Annual CCA (Years 2-7) 
Total CCA = $69,000 + ($138,000 * 6) 
Total CCA = $945,000

Now we can calculate the tax savings from CCA in year 5:

Tax Savings = CCA * Marginal Tax Rate 
Tax Savings = $138,000 * 40% 
Tax Savings = $55,200

However, since we're assuming the half-year rule applies to year 1, we need to adjust the CCA for year 5 accordingly:

Adjusted CCA (Year 5) = Depreciation Rate * (1/2) * Depreciation Base 
Adjusted CCA (Year 5) = 30% * (1/2) * $460,000 
Adjusted CCA (Year 5) = $34,500

Tax Savings (Year 5) = Adjusted CCA (Year 5) * Marginal Tax Rate 
Tax Savings (Year 5) = $34,500 * 40% 
Tax Savings (Year 5) = $13,800

Therefore, the tax savings from CCA in year 5 is $13,800, which corresponds to option B.

Laurentide Resort Corporation Is Considering a Seven-Year Project That Requires