Canadian Auto Shop Services has an opportunity to invest $550,000 in a new project that will generate additional operating profit of $200,000 per year.The asset has a six-year life, a CCA rate of 30%, and an expected salvage value of $60,000.The company's cost of capital is 12% and marginal tax rate is 35%.The risk premium for this type of project is 1.5%.Assume the asset class remains open after the asset is sold and the half-year rule applies in the first year.What is the project's NPV?

Question

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The correct answer is A. The project's NPV is $108,680.The project's cash flows are as follows:Year 0: -$550,000Year 1: $200,000 * (1 - 0.35) * (1 - 0.12) * (1 - 0.015) = $108,680Year 2: $200,000 * (1 - 0.35) * (1 - 0.12) * (1 - 0.015) = $108,680Year 3: $200,000 * (1 - 0.35) * (1 - 0.12) * (1 - 0.015) = $108,680Year 4: $200,000 * (1 - 0.35) * (1 - 0.12) * (1 - 0.015) = $108,680Year 5: $200,000 * (1 - 0.35) * (1 - 0.12) * (1 - 0.015) = $108,680Year 6: $200,000 * (1 - 0.35) * (1 - 0.12) * (1 - 0.015) + $60,000 = $173,680The project's NPV is the sum of the present value of these cash flows, which is $108,680.

Canadian Auto Shop Services Has an Opportunity to Invest $550,000