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    Corporate Finance Week 3 Slide Solutions

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    Kate B

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    Corporate Finance Week 3 Slide Solutions

    Uploaded by

    Kate B
    34 views6 pages

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    Prep-COF-W03.SLDS.I

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    34 views6 pages

    Corporate Finance Week 3 Slide Solutions

    Uploaded by

    Kate B

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 6

    Corporate Finance

    Week 3
    Slide Solutions

    Chartered Professional Accountants of Canada, CPA Canada, CPA


    are trademarks and/or certification marks of the Chartered Professional Accountants of Canada.
    © 2020, Chartered Professional Accountants of Canada. All Rights Reserved.
    2020-07-16
    Corporate Finance Week 3 — Slide Solutions

    WEEK 3 — SLIDE SOLUTIONS

    Solution to Slides 12 and 13, Capital budgeting: Cash flows — Exercise 1

    1. Initial investment
    • Building $2,500,000
    • Machine plus installation 850,000
    • Land: 750,000 – [0.32 × ½ × (750,000 – 400,000)] 694,000
    • Working capital 300,000

    2. Salvage (at the end of Year 8)


    • Building $625,000
    • Machine 85,000
    • Land: 900,000 – [0.32 × ½ × (900,000 – 750,000)] 876,000
    • Working capital 300,000

    3. Operations
    • Annual after-tax incremental revenues: (1 – 0.32) × 200,000 × $15 $2,040,000
    • Annual costs: (1 – 0.32) × 200,000 × $8 1,088,000
    • CCA tax shield — building and machine

    Solution to Slide 23, CCA tax shield — Exercise 2a

    Net acquisition = (150,000 + 25,000) – 35,000 = $140,000

    Year 1: CCA = 140,000 × 1.50 × 0.20 = $42,000


    CCA tax shield = 42,000 × 0.30 = $12,600

    Year 2: CCA = (140,000 – 42,000) × 0.20 = $19,600


    CCA tax shield = 19,600 × 0.30 = $5,880

    Year 3: CCA = (140,000 – 42,000 – 19,600) × 0.20 = $15,680


    CCA tax shield = 15,680 × 0.30 = $4,704

    Manor will enjoy a tax shield (reduced taxes payable) from the CCA deduction of
    $12,600 in Year 1, $5,880 in Year 2, and $4,704 in Year 3.

    At the end of Year 3, the remaining UCC balance related to this machine is $62,720
    (= 140,000 – 42,000 – 19,600 – 15,680), and the new model will then be sold for
    $28,000.

    1/5
    Corporate Finance Week 3 — Slide Solutions

    At the time of the sale, the UCC balance will be reduced by $28,000. As Manor will
    continue to have assets in the same pool, the residual UCC will remain eligible for CCA
    into the future. Assuming the asset class pool remains open, Manor can continue to
    benefit from a CCA tax shield on the asset indefinitely.

    Solution to Slide 24, CCA tax shield — Exercise 2b

    Net acquisition = (150,000 + 25,000) – 35,000 = $140,000

    Year 1: CCA = 140,000 × 100% = $140,000


    CCA tax shield = 140,000 × 0.30 = $42,000

    Year 2: CCA = (140,000 – 140,000) × 0.50 = $0


    CCA tax shield = $0

    Year 3: CCA = $0
    CCA tax shield = $0

    Manor will enjoy a tax shield (reduced taxes payable) from the CCA deduction of
    $42,000 in Year 1 and $0 thereafter.

    At the end of Year 3, the remaining UCC balance is $0.

    At the time of the sale, the UCC balance will be reduced by $28,000. As Manor will
    continue to have assets in the same pool, the remaining UCC will still be eligible for
    CCA into the future. Because the asset class pool remains open, and assuming the
    UCC balance prior to the sale is at least $28,000, Manor will avoid recapture on the
    sale.

    Solution to Slide 27, PVCCA tax shield — Exercise 3


    140,000(0.20)(0.30) 1+(1.5 ×0.08)
    a) = × = $31,111
    0.20+0.08 1+0.08

    This PVCCA tax shield figure of $31,111 represents the present value of the total
    CCA tax shield that Manor would benefit from if it doesn’t dispose of the machine at
    the end of its useful life (three years).

    If Manor sells the machine at the end of Year 3, the UCC balance will be reduced by
    the proceeds, and the ongoing CCA tax shield will be reduced accordingly.

    b) = ($140,000 × 100% × 30%) / (1.08) = $38,889

    This PVCCA tax shield figure of $38,889 represents the present value of the total
    CCA tax shield that Manor would benefit from if it doesn’t dispose of the machine at
    the end of its useful life (three years).

    2/5
    Corporate Finance Week 3 — Slide Solutions

    If Manor sells the machine at the end of Year 3, the UCC balance will be reduced by
    the proceeds, and the ongoing CCA tax shield will be reduced accordingly.

    Solution to Slide 30, PVCCA tax shield lost — Exercise 4

    a) PVCCA tax shield lost: [(28,000)(0.20)(0.30)]/(0.20 + 0.08) × 1/(1 + 0.08)3 = $4,763


    b) Taxes on salvage: 28,000 × 30% = $8,400

    Present value of taxes on salvage = $8,400/1.083 = $6,668

    Solution to Slide 31, PVCCA tax shield and PVCCA tax shield lost — Exercise 5

    Building:
    2,500,000(0.04)(0.32) 1.21
    PVCCA tax shield = × = $188,694
    0.04 + 0.14 1.14

    625,000(0.04)(0.32) 1
    PVCCA tax shield lost = × = $15,580
    0.04 + 0.14 (1.14)8

    Machine:
    850,000(0.20)(0.32) 1.21
    PVCCA tax shield = × = $169,825
    0.20 + 0.14 1.14

    85,000(0.20)(0.32) 1
    PVCCA tax shield lost = × = $5,609
    0.20 + 0.14 (1.14)8

    Solution to Slides 33 to 35, Capital budgeting: NPV — Exercise 6

    1. Initial investments
    Facility $1,500,000
    Equipment 200,000
    Land: 250,000 – [0.37 × ½ × (250,000 – 200,000)] 240,750
    Working capital 50,000
    $1,990,750

    2. Salvage — proceeds (at the end of Year 6)


    Facility $ 750,000
    Equipment 25,000
    Land: 300,000 – [0.37 × ½ × (300,000 – 250,000)] 290,750
    Working capital 50,000
    $1,115,750

    3/5
    Corporate Finance Week 3 — Slide Solutions

    3. Annual incremental after-tax operating income


    Annual net revenues: (1 – 0.37) × $500,000 $315,000
    Lost revenues annually: (1 – 0.37) × $100,000 (63,000)
    Net annual incremental after-tax revenues $252,000

    4. PVCCA tax shield and PVCCA tax shield lost


    Facility:
    1,500,000(0.06)(0.37) 1.165
    PVCCA tax shield = × = $205,588
    0.06 + 0.11 1.11

    750,000(0.06)(0.37) 1
    PVCCA tax shield lost = × = $52,363
    0.06 + 0.11 (1.11)6

    Equipment:
    PVCCA tax shield = ($200,000 × 100% × 37%) / (1.11) = 66,667
    25,000(0.50)(0.37) 1
    PVCCA tax shield lost = × = $4,054
    0.50 + 0.11 (1.11)6

    Summary:
    Initial investments: $(1,990,750)

    Salvage: $1,115,750 / (1.11)6 596,526

    Incremental revenue: 1,066,096


    PMT = 252,000 I/Y = 11% N=6 CPT PV

    PVCCA tax shield and PVCCA tax shield lost:


    Facility: PVCCA tax shield 205,588
    PVCCA tax shield lost (52,363)
    Equipment: PVCCA tax shield 66,667
    PVCCA tax shield lost (4,054)
    NPV $(112,290)

    As the NPV is negative, Eureka should not build the new facility.

    4/5
    Corporate Finance Week 3 — Slide Solutions

    Solution to Slide 40, Capital budgeting: Payback period — Exercise 7

    For Project A
    PBPA = 32,000 ÷ 4,500 = 7.1 years

    For Project B
    Year 1 Year 2 Year 3 Year 4 Year 5
    Beginning investment balance $600,000 $500,000 $370,000 $215,000 $ 65,000
    Less: annual cash flow 100,000 130,000 155,000 150,000 170,000
    Remaining investment balance $500,000 $370,000 $215,000 $ 65,000 $(105,000)

    Payback is achieved between Years 4 and 5.

    PBPB = 4 + (65,000 ÷ 170,000) = 4.4 years

    Solution to Slide 43, Capital budgeting: Internal rate of return — Exercise 8

    –850,000 + 170,000 × PVAF (IRR%, 10) = 0

    IRRC = 15.0984%

    PMT = $170,000 N = 10 PV = –$850,000 CPT I/Y% = 15.0984%

    5/5

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