We need to decide to purchase a system and have 2 options.Note that The infrastructure (capital) will be built immediately (year 0).
Option A will cost $14 million and will last 5 years. It is expected to have a salvage value of $2 million at the end of the 5th year. Revenues in year 1 will be $4.4 million, and operational costs in year 1 will be $1 million. Option B will cost $20 million. It is expected to have a salvage value of $1.3 million at the end of the 5th year. Revenues in year 1 will be $6.6 million, and operational costs in year 1 will be $1.8 million.
For both options: revenues and future operating costs are expected to rise at 2% per year after year 1. The combined federal and provincial incremental tax rate is 35%. Use a CCA depreciation rate of 45% and a discount rate of 5% (reflecting the borrowing costs of the firm).
a What is the gain or loss on disposal of Option A (rounding to the nearest dollar)?
b What is the gain or loss on disposal of Option B (rounding to the nearest dollar)?
c Determine the net present worth of the after-tax cash flow for each option.
d Which option should he recommend, or should we recommend not to purchase either?
