Question Tax shield approach

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Question (Tax shield approach)

• Ilana Industries, Inc., is considering buying a
  new machine at a cost of 1M. The machine will
  cost 35,000 to run and will generate products at
  a market value of 125,000 for the next 10 years.
  The machine is an asset class with a CCA rate of
  25, and Ilana has many other assets in this
  asset class. The salvage (market value) of the
  machine after 10 years is 100,000. The discount
  rate is 10 and corporate tax rate is 35.
  Calculate the NPV of buying the machine.

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Example A Cost-Cutting Proposal
Consider a 10,000 machine that will reduce
pretax operating costs by 3,000 per year over a
5-year period. Assume no changesin net working
capital and a scrap (i.e., market) value of
1,000 after five years. For simplicity, assume
straight-line depreciation to zero. The marginal
tax rate is 34 and the appropriate discount
rate is 10.
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Equivalent Annual Cost
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Replacing an old machine

• You are operating an old machine which will last
  2 more years.
• It costs 12,000 per year to operate.
• A new machine costs 25,000 to buy, but is more
  efficient and can be operated for 8,000 per
  year. It will last for 5 years.

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Example Equivalent Annual Cost Analysis

• Two types of batteries are being considered for
  use in electric golf carts at City Country Club.
  Burnout brand batteries cost 36, have a useful
  life of 3 years, will cost 100 per year to keep
  charged, and have a salvage value of 5.
• Longlasting brand batteries cost 60 each, have
  a life of 5 years (assume straight line
  depreciation), will cost 88 per year to keep
  charged, and have a salvage value of 5.
• Required return is 15. Which type of battery
  should be used?

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Capital budgeting Aqua-Products currently
manufactures a wide range of equipment for water
sports. The company is re-evaluating its rubber
rowboat product line to determine whether it will
continue to be profitable or whether it should be
discontinued. Net operating revenues before tax
(i.e., sales minus all operating costs) are
estimated to be 180,000 per year for each of the
next 10 years. It is estimated that the rubber
rowboat product line has a useful life of 10
years that is, after year 10 no further revenues
are anticipated from this particular product line
and the economic value of all machinery used to
produce the rubber rowboats will be zero.
Continued production of this product line
requires that finished goods inventory of rubber
rowboats be maintained at a level of 64,000
throughout the ten year life of the project. (If
this product line were discontinued, obviously
the level of finished goods inventory of rubber
rowboats would be reduced to zero.) If the
rubber rowboat product line were shut down, there
would be immediate expenses (100 tax deductible)
of 270,000. On the positive side, machinery
formerly used in the production process could be
sold for 720,000. This machinery is in asset
class 39, which is allowed a CCA rate of 25. The
firm also has many other assets in this class.
The floor space that is vacated by the shutdown
could be leased out at 75,000 per year. The
firms tax rate is 40, and the appropriate
discount rate is 14. Based on an NPV analysis,
should Aqua-Products continue to manufacture
rubber rowboats or close down this one product
line? Explain all the steps taken to reach your
conclusion structuring of the problem and
analysis should be explained in words as well as
given by calculations. Simply providing a
numerical answer is not sufficient.