B. Problem Statement

You are projecting the purchase of a small restaurant in Kanata. The financial information on this potential investment includes:

1. Projected ownership of 4 years.

2. Rental revenues before taxes of $600,000 at EOY1 increasing annually

   thereafter by $3,000.

3. Annual expenses before taxes of $250,000 at EOY1 increasing annually

   thereafter by 2%.

4. Todays asking price for the building is $950,000 with an expected selling

   price of $800,000 in 4 years.

5. The Canadian income tax rate on this type of investment is assumed to

   be 40% (on profits before taxes, capital gains or losses, terminal losses

   and on recaptured depreciation).

6. Buildings and equipment are to be depreciated using the DB method with

   a 15% depreciation rate.

7. The half-year rule applies to the depreciation of capital assets.

8. Working capital = $2,000.

9. You will need a $550,000 loan at a 10% rate to finance, in part, your

   purchase and the required working capital. The loan is to be repaid as follows:

   • EOY1 = 10% of the total loan

   • EOY2 = 20%

   • EOY3 = 30%

   • EOY4 = 40%

10. The annual inflation rate is 1.0%.

11. MARRs are:

    • Before-taxes with inflation = 15.0%

    • Before-taxes without inflation (inflation-free) = 14.0%

    • After-taxes with inflation = 9.0%

    • After-taxes without inflation (inflation free) = 8.0%

      BTCF = Before-Tax Cash Flow; ATCF = After-Tax Cash Flow; CFOE = Cash Flow on Owner Equity.

Please answer the following questions:

1. The cost (closest $1,000) of the paving equipment before the tax-savings from annual depreciation is: a) 800,000; b) 950,000; c)1,000,000; d) 1,200,000.

2. The cost (closest $1,000) of the rental property after the tax-savings from annual depreciation is:

a) 801,000; b) 826,000; c) 950,000; d) 1,000,000.

l END-OF-YEAR (EY) 2 | 3 | | T CCT GG HH MM Cash Flows Tol Annual revenues (AR) Actual $) Annual costs (AC) Actual $) 1. BTCF "Operations" (Actual $) T T 2. BTCF "SV" (Actual $) 3. BTCF "Working Capital (Actual $) EE 4. Total BTCF (Actual $) 5. BTCF "Operations" (Constant $) 6. BTCF "SV" (Constant $) 7. BTCF "Working Capital" (Constant $) 8. Total BTCF (Constant $) 9. Annual Depreciation 10. Interest on loan 11. Taxable Operating Income 12. Taxes on Operating Income 13. Capital gains 14. Taxes on capital gains 15. Recaptured depreciation (or terminal loss) 16. Taxes on recaptured depreciation (or terminal loss) 17. ATCF "Operations" (Actual $) 18. ATCF "Operations" (Constant $) 19. ATCF "SV" (Actual $) 20. ATCF "SV" (Constant $) 21. ATCF "Working Capital" Actual $) 22. ATCF "Working Capital" (Constant $) 23. Total ATC (Actual ) 24. Total ATCF (Constants) 25. (=R10.) Interest on loan 26. Loan repayment 27. CFOE (Actual $) 28. CFOE (Constant $) NN 00 PP RR UU WW YYZZ l END-OF-YEAR (EY) 2 | 3 | | T CCT GG HH MM Cash Flows Tol Annual revenues (AR) Actual $) Annual costs (AC) Actual $) 1. BTCF "Operations" (Actual $) T T 2. BTCF "SV" (Actual $) 3. BTCF "Working Capital (Actual $) EE 4. Total BTCF (Actual $) 5. BTCF "Operations" (Constant $) 6. BTCF "SV" (Constant $) 7. BTCF "Working Capital" (Constant $) 8. Total BTCF (Constant $) 9. Annual Depreciation 10. Interest on loan 11. Taxable Operating Income 12. Taxes on Operating Income 13. Capital gains 14. Taxes on capital gains 15. Recaptured depreciation (or terminal loss) 16. Taxes on recaptured depreciation (or terminal loss) 17. ATCF "Operations" (Actual $) 18. ATCF "Operations" (Constant $) 19. ATCF "SV" (Actual $) 20. ATCF "SV" (Constant $) 21. ATCF "Working Capital" Actual $) 22. ATCF "Working Capital" (Constant $) 23. Total ATC (Actual ) 24. Total ATCF (Constants) 25. (=R10.) Interest on loan 26. Loan repayment 27. CFOE (Actual $) 28. CFOE (Constant $) NN 00 PP RR UU WW YYZZ