Question

replacement decisions (lo6) a university student painter is considering the purchase of a new air compressor and paint gun to replace an old paint sprayer. (both items belong to class 9 and have a 25% cca rate.) these two new items cost $12,000 and have a useful life of four years, at which time they can be sold for $1,600. the old paint sprayer can be sold now for $500 and could be scrapped for $250 in four years. the entrepreneurial student believes that operating revenues will increase annually by $8,000. should the purchase be made? the tax rate is 22% and the required rate of return is 15%.

Answer 1

To determine if the student painter should purchase a new air compressor and paint gun, the financial implications, including tax deductions, increased revenues, and required return on investment, must be considered along with CCA and salvage values.

Step-by-step explanation:

The question pertains to making a replacement decision involving the purchase of a new air compressor and paint gun by a university student painter. To determine whether the purchase should be made, we need to assess the financial implications considering the cost of new equipment, the salvage value of old and new equipment, the impact on operating revenues, as well as the applicable tax rate and the required rate of return.

An important factor in this decision is the calculation of Capital Cost Allowance (CCA), which is a tax deduction in Canada for depreciation, specific to the asset class in question. In this case, both the old equipment and the new equipment fall into Class 9 with a CCA rate of 25%. The increased annual operating revenue of $8,000 must be accounted for after taxes, as this affects the net benefit of the new investment. Furthermore, the cost of capital should be considered by applying the required rate of return of 15% in a net present value analysis to determine if the return justifies the investment.