Learning Objectives
4. Appraise the use of the cost of capital as the
discount rate in capital budgeting analysis.
(LO4)
5. Integrate the cash flows that result from an
investment decision, including the after tax
operating benefits and the tax shield benefits of
capital cost allowance (amortization). (LO5)
6. Perform NPV analysis to assist in the decisionmaking process concerning long-run
investments. (LO6)
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LO5
Capital Cost Allowance
• Amortization for income tax purposes
• Capital Cost Allowance (CCA) is the maximum
amount of amortization allowable under the tax act
• Capital assets are divided into a number of classes
(pools)
• Each class is assigned a CCA rate;
– ex. Class 8 is Machinery with a rate of 20%
• CCA is calculated on the Un-depreciated Capital Cost
(UCC) in the pool (declining balance)
• CCA provides a tax shield over the life of the
investment
• A formula provides the present value of the CCA tax
shield
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LO5
Capital Cost Allowance: tax savings
Before CCA Expense
Income (cash
flow)…………….
After CCA Expense
$12,000 Income (cash
flow)………….
Tax @
40%...............................
4,800
Income (cash flow) after
taxes
$ 7,200
CCA………………………
…..
5,000
Taxable
Income……………..
7,000
Tax @
40%...........................
2,800
Income after
taxes………….
Add back
CCA………………
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$12,000
$4,200
5,000
Income/cash flow after
$9,200
taxes
©2012 McGraw-Hill Ryerson Limited
LO5
Table 12-8
Some declining balance CCA classes
Class
Rate
Assets
Class 1
4% Bridges, buildings, dams
Class 3
5
Class 6
10
Greenhouses, hangars, wood jetties
Class 7
15
Boats, ships
Class 8
20
Most machinery, radio communications equipment
Class 9
25
Aircraft
Class 10
30
Automobile equipment, computer hardware, feature films
Class 12
100
Class 16
40
Class 17
8
Class 30
40
Telecommunications spacecraft
Class 33
15
Timber resource property
Class 42
12
Fibre optic cable
Class 45
55
Computer equipment and systems (increase from 45%)
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Windmills, telegraph poles
Cutlery, television commercials, computer software
Taxicabs, autos for short-term rental, video games (coin)
Roads, storage area
©2012 McGraw-Hill Ryerson Limited
LO5
Table 12-9
Capital Cost Allowance for investment A or B
Year 1:
Net original cost………………………………………………………………………………………….
$10,000
Less: Capital cost allowance ½ ($10,000 x 0.20)…………………………………………………….
1,000
Undepreciated capital cost*…………………………………………………………………………….
$ 9,000
Year 2:
Less: Capital cost allowance ($9,000 x 0.20)…………………………………………………………
1,800
Undepreciated capital cost……………………………………………………………………………...
$ 7,200
Year 3:
Less: Capital cost allowance ($7,200 x 0.20)…………………………………………………………
1,440
Undepreciated capital cost……………………………………………………………………………...
$ 5, 760
Year 3:
Less: Capital cost allowance ($5,760 x 0.20)…………………………………………………………
1,152
Undepreciated capital cost……………………………………………………………………………...
$ 4,608
Year n:
Undepreciated capital cost (for year n – 1)……………………………………………………………
Less: Capital cost allowance (UCC in year n – 1 x 0.20)……………………………………………
Equals: Undepreciated capital cost (for year n)………………………………………………………
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LO5
Table 12-10
Liquidation of Asset Pool
Outcome 1
Outcome 2
Outcome 3
Outcome 4
$12,960
$12,960
$12,960
$12,960
Sale price – A…………………………
5,000
7,000
7,500
12,000*
Sale price – B…………………………
5,000
5,960
7,500
7,200
Balance in pool………………………..
$ 2,960
$
0
$ (2,040)
$(4,240)
Capital gain……………………………
$
0
$
0
$
$ 2,000
From CCA pool…………………………..
$
1,184
$
0
$ (816)
$ (1,696)
From capital gain………………………...
$
0
$
0
$
0
$
$
1,184
$
0
$
(816)
Year 3:
UCC……………………………………
Year 4:
0
Tax consequences (@ 40%)
Positive values are tax savings:
(400)
$ (2,096)
*Only original cost of $10,000 is deducted from pool; excess of $2,000 is capital gain
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