M Dana's Dressmakers and Alterations Ltd. is looking at the purchase of several serging machines for their new third location. The company can buy the equipment for $6,000 and finance it with a three-year operating loan at 6% where interest is paid at the end of each year and the principal is paid at the end of the term. The capital cost allowance rate (CCA) is 25% and the income tax rate is 30%. What is the present value of the tax shield from the equipment purchase over the first three years if the cost of capital is 6%?

Question

Quizplus · Accepted Answer

The present value of the tax shield from the equipment purchase can be calculated using the CCA rate, the cost of the equipment, the income tax rate, and the cost of capital. The tax shield in each year is the CCA (25% of the undepreciated balance of the equipment) multiplied by the tax rate (30%). The present value of these tax shields over the three years is then discounted back at the cost of capital (6%). The calculation shows that the present value of the tax shield is closest to $1,099.