Question

Maple Leafs Sports & Entertainment is considering purchasing one of the following two pieces of lighting equipment. Equipment A has a purchase price of $10 million and will cost, $240,000 pre-tax, to operate on an annual basis. This equipment will have to be replaced every 5 years and has a salvage value of $1 million. Equipment B on the other hand, has an initial cost of $14 million and costs $210,000 pre-tax, annually to operate. This equipment has a useful life of 7 years with a salvage value of $1.2 million. Both equipment sets are in an asset class with a CCA Rate of 30% and are otherwise identical. The income tax rate is 40 percent and the appropriate discount rate is 10%. Which equipment should the company purchase and why?

Answer #1

1. calculation of total cash outflow in equipment A

depreciation = 10 m/n - 1 m/n

5 years

depreciation = 1.8 m/n p.a

total cost of operating = 0.24 m/n per year

thus, total cash outflow = 2.04 m/n

less : tax @ 40 % = (0.82 m/n)

total outflow after tax = 1.22 m/n

Therefore, the discounted cash outflow will be $ 0.32 m/n p.a

2. Calculation of cash outflow in Equipment B

calculation of depreciation = 14 m/n - 1.2 m/n

7 years

depreciation = 1.83 m/n p.a

+ othercost = .0.21 m/n p.a

total pretax outflow = 2.04 m/n

less : tax = 0.82 m/n

outflow after tax = 1.22 m/n

therefore, the discounted cashflow will be $ 0.25 m/n

hence, it is advisable to purchase equipment B as it is having lower cash outflow as compared to equipment A

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