Annual Cash Cash Flows

The Annual Cash Flows

• Represent any changes (incremental) in operating cash caused by the investment or project.
• Increases with any incremental revenue.
• Decreases with any incremental cost.
• Additional income tax is deducted to net after-tax operating cash flows

CCA Tax Shield

• The tax shield is the amount of income tax that the company saves as a result of the depreciation expense on the asset it is considering purchasing.
• Is treated as a cash inflow for capital budgeting pursposes

Capital Cost Allowance (Straight-Line)

• CCA is the tax deductible depreciation expense.
• Measured on the basis of cost, residual value and useful life.
• Cost: The total cost to of the asset including all capitalized expenditures.
• Residual value: The amount of cash we believe we can recover when the asset is sold.
• Useful life: The number of years we plan on using the asset for.
• Equal amount of depreciation in each year

Example: Annual Cash Flows

• The project requires the purchase of a new machine costing $600,000, delivery of the machine is expected to cost $50,000, and the opportunity cost of the project is $30,000.
• The research cost associated with the project is $15,000.
• The machine has a useful life of 5 years and a $75,000 salvage value. Assets are depreciated using the straight-line method.
• Management believes that sales will increase by $300,000 and related expenses are expected to be $80,000 per year.
• Inventory will increase immediately by $15,000 and no additional working capital is required, inventory will no longer be needed at the end of the project.
• The cost of capital is 12% and the marginal tax rate is 30%.

Capital Cost Allowance (Rates)

• CCA is the tax deductible depreciation expense.
• Based on the cost of the asset and the asset specific depreciation rate set by the tax code.
• Cost: The total cost to of the asset including all capitalized expenditures.
• Asset's depreciation is based on its undepreciated capital cost (UCC) from the previous period.
• Will have more depreciation in the early life of the assets.
• Subject to the half-year rule
• In the first year the asset is owned, the firm can only report half the amount of CCA.

Example: Operating Cash Flows

• The project requires the purchase of a new machine costing $600,000, delivery of the machine is expected to cost $50,000, and the opportunity cost of the project is $30,000.
• The research cost associated with the project is $15,000.
• The machine has a useful life of 5 years and a $75,000 salvage value. The machinery is depreciated using a CCA rate of 30% and the half year rule applies.
• Management believes that sales will increase by $300,000 and related expenses are expected to be $80,000 per year.
• Inventory will increase immediately by $15,000 and no additional working capital is required, inventory will no longer be needed at the end of the project.
• The cost of capital is 12% and the marginal tax rate is 30%.