Reference no: EM131800287
You are planning a project with an expected lifetime of 5 years. Your after-tax MARR is 20%. The project requires you to spend $120,000 on a capital asset right away, and Revenue Canada allows this asset to depreciate at 30%. You will have to spend $100,000/year on salaries associated with the project. Assume these salaries are paid at the end of each year, starting a year from now. Sales associated with the project are expected to bring in $50,000 a year, starting two years from now, and to go up by $50,000 a year. The final sales payment, of $200,000, occurs five years from now.
Sales figures are not reliable beyond five years from now. In five years time, you expect to sell the capital equipment for $300,000. Corporate profits are currently taxed at 20%, and capital gains are taxed at 10%.
In one year's time, there will be a federal election. There is a 50% chance that the Blue party will stay in power, in which case taxes will stay at the same level. However, there is also a 50% chance that the Orange party will get in, in which case the corporate tax rate and the capital gains tax will both go up to 40%. If these changes occur, they will be implemented before you pay your tax bill for the first year. The depreciation rate for the capital asset is not expected to change.
Should you start the project now, or wait a year to see who wins the election? If you wait, you still have to buy the capital asset now, but it will be two years before you start paying salaries, and three years before you start making sales, again at $50,000 a year at the end of Year 3, $100,000 at the end of Year 4, $150,000 at the end of Year 5; and beyond Year 5 you have no basis for prediction.
Assume that your company has other profitable ventures, so that you show a net profit every year. One consequence of this is that, if this project loses $100 in a given year, the after-tax value of this loss is only -$100(1-t), where t is the tax rate (since you can use the $100 loss to avoid paying taxes of $100t on your $100 profit from another venture).
It will probably be easier to calculate the CCA each year, rather than trying to calculate the CTF.