Suppose a project requires a capital investment of $300,000.The project will last for six years, at which time the asset will be sold for $90,000.The asset is a Class 8 asset, with a CCA rate of 20%.The firm's marginal tax rate is 40%.The firm's required rate of return is 8%.Assume the asset class remains open after the asset is sold.What is the present value of the CCA tax savings for the project assuming half-year rule is applicable for CCA in year 1?

Question

Quizplus · Accepted Answer

Step 1: Calculate the Capital Cost Allowance (CCA) for the asset:
Year 1: Half-year rule applies, so CCA = 0.5 x 20% x $300,000 = $30,000
Year 2-6: CCA = 20% x $300,000 = $60,000 each year
Total CCA over 6 years = $30,000 + ($60,000 x 5) = $330,000

Step 2: Calculate the tax savings from CCA:
Tax savings = CCA x marginal tax rate = $330,000 x 40% = $132,000

Step 3: Calculate the present value of the tax savings:
PV = (Tax savings / (1 + required rate of return)^1) + (Tax savings / (1 + required rate of return)^2) + … + (Tax savings + salvage value / (1 + required rate of return)^6) = ($132,000 / 1.08^1) + ($132,000 / 1.08^2) + … + ($222,000 / 1.08^6) = $66,335.32

Therefore, the present value of the CCA tax savings for the project assuming half-year rule is applicable for CCA in year 1 is $66,335.32, so the best choice is C.

Suppose a Project Requires a Capital Investment of $300,000