Stewiacke Ltd. is currently considering a project with a four-year life that it believes may
return the company to profitability. Stewiacke recently did a market survey at a cost of
$100,000. The market survey indicated that the consumer response to its new product
is likely to be favourable.
The project will require an initial investment of $8 million: $4 million for a new building
and $4 million for new equipment. Stewiacke also believes that to undertake the project,
it will have to increase its investment in net working capital from $1 million to
$1.5 million.
Stewiacke intends to build on a block of land that it purchased last year for $2 million.
The land has a current market value of $2.5 million. If the land were sold today,
Stewiacke would owe approximately $67,500 of income tax on the gain. Independent
appraisers have indicated that it should be worth $2.9 million after taxes in four years.
The equipment is estimated to have a four-year useful life; at the end of its useful life, it
is expected to have a salvage value equal to 15% of its original purchase price. The
building is estimated to have a 15-year useful life; at the end of the 15 years, its salvage
value is expected to be 25% of its original cost. At the end of Year 4, the building is
expected to be worth 50% of its original cost. Both the building and equipment will be
depreciated on a straight-line basis for accounting purposes.
The project is expected to generate gross revenues of $6 million per year, and the cost
of goods sold is expected to remain constant at 55% of gross revenues. Finally,
Stewiacke's marginal tax rate is 27%, and the applicable CCA rates on the new building
and the new equipment are 10% and 20%, respectively, and additions qualify for the AII
of 1.5 times the CCA rate in the year of acquisition. Assume there are still assets
remaining in the UCC class and that there is a positive balance in the class even after
the salvage proceeds are deducted.
The appropriate discount rate for this project is 12%.
 

Required:
Identify and calculate the relevant cash flows for use in a capital budgeting analysis, on
an after-tax basis. Also identify any cash flows that might not be relevant and explain
why

 

Answer rating: 100% (QA)

Relevant Cash Flows 1 Initial Investment Building cost 4 million Equipment cost 4 million Increase i... View the full answer