© 2012 McGrawHill Ryerson Ltd. Chapter 9 -1

In Canada, taxable income is based on a deduction called Capital Cost Allowance (CCA):

Taxable Income = Revenues - Expenses - CCA ◦ The terms depreciation and CCA are often used

interchangeably

Capital Cost Allowance (CCA)◦ The amount of write-off on depreciable assets

allowed by Canada Revenue Agency against taxable income

Un-depreciated Capital Cost ◦ The balance remaining in an asset class that

has not yet been depreciated in that year

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© 2012 McGrawHill Ryerson Ltd. Chapter 9 -2

The tax savings arising from CCA is called the CCA tax shield

◦ For calculating CCA, assets are assigned to different asset classes. These classes have specified CCA rates

Sale of Assets Termination of Asset Pool

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© 2012 McGrawHill Ryerson Ltd. Chapter 9 -3

Intangible assets use a straight-line depreciation method for computing CCA

Most asset classes use a declining balance method for computing CCA.

◦ The tax shield generated by CCA generally has an infinite life.

◦ Projects typically have a finite life.

When computing NPV, we calculate the present value of the operating cash flow separately from the present value of the CCA tax shields

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© 2012 McGrawHill Ryerson Ltd. Chapter 9 -4

where:C= capital cost of asset acquired todayd= CCA rate for the specified asset classTC = firm’s tax rater = discount rateS = salvage value from sale of asset at the end of Year t

tCC

rdr

SdT

r

r

dr

CdT

1

1

1

5.01

The PV of the CCA Tax Shield is equal to

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© 2012 McGrawHill Ryerson Ltd. Chapter 9 -5

382,3950,2423,2755,1275,2after taxProfit

821,1588,1305,1945225,1(35%).Tax

203,5538,4728,3700,2500,3ProfitPretax

...612875250,1785,1550,2500,1equipment ofCCA

155,12576,11025,11500,10000,10Expenses

233,18364,17538,16750,15000,15Revenues

039,3678,1225214204575,2500,1in WC Change

0039,3717,4493,4279,4075,4500,1WC

00010Invest Cap

6543210Year

,

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© 2012 McGrawHill Ryerson Ltd. Chapter 9 -6

Operating Cash Flows excluding CCA tax shield:

Year 0 1 2 3 4 5Revenues 15,000 15,750 16,538 17,364 18,233- Expenses 10,000 10,500 11,025 11,576 12,155= Profit before tax 5,000 5,250 5,513 5,788 6,078- Tax @35% 1,750 1,838 1,930 2,026 2,127= Operating cash flow 3,250 3,412 3,583 3,762 3,951(excluding CCA tax shield)

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Total Cash Flows excluding CCA tax shield:

Year 0 1 2 3 4 5 6Capital Investment -10,000Change in working capital -1,500 -2,575 -204 -214 -225 1,678 3,039CF from operations 3,250 3,412 3,583 3,762 3,951Total cash flows(excluding CCA tax shield) -11,500 675 3,208 3,369 3,537 5,629 3,039

PV @ 12% = $1,040

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© 2012 McGrawHill Ryerson Ltd. Chapter 9 -8

Present Value of the CCA tax shield:

366,2

12.01

1

3.012.0

35.03.00

12.01

12.05.01

3.012.0

35.03.0000,10

1

1

1

5.01

6

tCC

rdr

SdT

r

r

dr

CdT

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Net present value =

total PV excluding CCA tax shield + PV of CCA tax shield = $1,040 + $2,366

= $3,406

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