Trudeau Analytical Services Inc. has the opportunity to increase its services of evaluating dril- ling results for exploration companies drilling for oil in the northern reaches of the Arctic. The additional services will generate about $1.2 million in additional annual revenues, with related cash expenditures of $800,000 per year.

In order to engage in these services, the company will require additional, very sophisticated testing equipment that will cost $1.5 million and will have a useful life of 20 years, at which time it can be sold for $150,000. This equipment will be categorized for tax purposes as Class 10 Equipment, with a CCA rate of 30 percent per year.

In addition to the equipment purchase, Trudeau will require $100,000 of additional working capital to support this venture. At the end of each five-year period, the company will be required to do maintenance on the new analyzing equipment at a cost of $50,000 each time.

Trudeau is subject to a combined federal and provincial income tax rate of 40 percent and expects a minimum after-tax return of 12 percent on any project that it engages in.

Required:

1. Prepare a memo outlining your recommendations to the management of the company as to whether the company should enter this new line of business. Show all calculations, and be very specific in your recommendation.

2. At what level of investment in the equipment would this project not be acceptable? Ignore the impact of the increased investment on the CCA tax shield.

3. Referring to the original facts, at what level of pre-tax income would this project not be acceptable?