1. ©2012 McGraw-Hill Ryerson Limited 1 of 45 Learning Objectives 4.Appraise the use of the cost of capital as the discount rate in capital budgeting analysis. (LO4) 5.Integrate the cash flows that result from an investment decision, including the after tax operating benefits and the tax shield benefits of capital cost allowance (amortization). (LO5) 6.Perform NPV analysis to assist in the decision- making process concerning long-run investments. (LO6)

2. ©2012 McGraw-Hill Ryerson Limited 2 of 45 Capital Cost Allowance Amortization for income tax purposes Capital Cost Allowance (CCA) is the maximum amount of amortization allowable under the tax act Capital assets are divided into a number of classes (pools) Each class is assigned a CCA rate; –ex. Class 8 is Machinery with a rate of 20% CCA is calculated on the Un-depreciated Capital Cost (UCC) in the pool (declining balance) CCA provides a tax shield over the life of the investment A formula provides the present value of the CCA tax shield LO5

3. ©2012 McGraw-Hill Ryerson Limited 3 of 45 Capital Cost Allowance: tax savings LO5 Before CCA ExpenseAfter CCA Expense Income (cash flow)……………. $12,000Income (cash flow)…………. $12,000 CCA……………………… ….. 5,000 Taxable Income…………….. 7,000 Tax @ 40%............................... 4,800Tax @ 40%........................... 2,800 Income (cash flow) after taxes $ 7,200Income after taxes…………. $4,200 Add back CCA……………… 5,000 Income/cash flow after taxes $9,200 Aftertax expense………...$5,000 (1- T) = $3,000 Tax savings…………………$5,000 (T) = $2,000 Before-tax expense $5,000

4. ©2012 McGraw-Hill Ryerson Limited 4 of 45 Table 12-8 Some declining balance CCA classes LO5 ClassRateAssets Class 1 4%Bridges, buildings, dams Class 3 5Windmills, telegraph poles Class 6 10Greenhouses, hangars, wood jetties Class 7 15Boats, ships Class 8 20Most machinery, radio communications equipment Class 9 25Aircraft Class 10 30Automobile equipment, computer hardware, feature films Class 12100Cutlery, television commercials, computer software Class 16 40Taxicabs, autos for short-term rental, video games (coin) Class 17 8Roads, storage area Class 30 40Telecommunications spacecraft Class 33 15Timber resource property Class 42 12Fibre optic cable Class 45 55Computer equipment and systems (increase from 45%)

5. ©2012 McGraw-Hill Ryerson Limited 5 of 45 Table 12-9 Capital Cost Allowance for investment A or B LO5 Year 1: Net original cost………………………………………………………………………………………….$10,000 Less: Capital cost allowance ½ ($10,000 x 0.20)……………………………………………………. 1,000 Undepreciated capital cost*…………………………………………………………………………….$ 9,000 Year 2: Less: Capital cost allowance ($9,000 x 0.20)………………………………………………………… 1,800 Undepreciated capital cost……………………………………………………………………………...$ 7,200 Year 3: Less: Capital cost allowance ($7,200 x 0.20)………………………………………………………… 1,440 Undepreciated capital cost……………………………………………………………………………...$ 5, 760 Year 3: Less: Capital cost allowance ($5,760 x 0.20)………………………………………………………… 1,152 Undepreciated capital cost……………………………………………………………………………... $ 4,608 Year n: Undepreciated capital cost (for year n – 1)…………………………………………………………… Less: Capital cost allowance (UCC in year n – 1 x 0.20)…………………………………………… Equals: Undepreciated capital cost (for year n)………………………………………………………

6. ©2012 McGraw-Hill Ryerson Limited 6 of 45 Table 12-10 Liquidation of Asset Pool LO5 Outcome 1Outcome 2Outcome 3Outcome 4 Year 3: UCC…………………………………… $12,960 Year 4: Sale price – A………………………… 5,000 7,000 7,500 12,000* Sale price – B………………………… 5,000 5,960 7,500 7,200 Balance in pool………………………..$ 2,960$ 0$ (2,040) $(4,240) Capital gain……………………………$ 0 $ 2,000 Tax consequences (@ 40%) Positive values are tax savings: From CCA pool…………………………..$ 1,184$ 0$ (816)$ (1,696) From capital gain………………………...$ 0 $ (400) $ 1,184$ 0$ (816)$ (2,096) *Only original cost of $10,000 is deducted from pool; excess of $2,000 is capital gain