Delta Co is evaluating a project with a five-year life. The initial cost of the asset is $500,000 and it has an expected scrap value of $50,000 at the end of Year 5. The company plans to finance the project using a bank loan at an interest rate of 8%. The company's weighted average cost of capital (WACC) is 12%. Taxation is at 25%, paid in the year it occurs, and Tax-Allowable Depreciation (TAD) is available at 25% on a reducing balance basis. In calculating the relevant cash flows for the Net Present Value (NPV), how should the financing costs and TAD be treated?

Question

Accepted Answer

Interest should be ignored; TAD tax savings should be calculated on the $500,000 cost, with a balancing allowance or charge in Year 5.

Answer

Both interest and TAD tax savings should be ignored as they are already accounted for within the 12% WACC.

Answer

Interest should be ignored; TAD tax savings should be calculated using the $500,000 cost less the $50,000 scrap value and included as inflows.

Answer

Interest of $40,000 per year should be included as an outflow; TAD tax savings should be calculated based on the $500,000 cost and included as inflows.

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