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Midnight Oil and Gas is considering building a pipeline from a remote source of gas with only a 10 year supply of reserves. This qualifies the pipeline for a CCA rate of 20 percent rather than the normal 4 percent. The pipeline will cost $1 million; accompanying buildings will cost another $200,000. The buildings are Class 1 with a CCA rate of 4 percent.
Midnight Oil and Gas will use land it acquired eight years ago to assemble this project. The land was purchased for $500,000, and it is now worth $2 million. Annual cash flows before amortization from the pipeline and taxes for the 10-year period are estimated at $625,000. In 10 years the buildings and pipeline will be worthless, but the land will be worth $4.5 million. Environmental clean-up costs at the end of the project are expected to be $1.2 million.
Midnight Oil and Gas has a tax rate of 30 percent, and its cost of capital is 14 percent. Capital gains are taxed at 50 percent of the gain. Should Midnight Oil and Gas build the pipeline?
· Isolate cash inflows (or savings) versus cash outflows (costs, taxes)
· Annual inflows will be subject to taxation.
· Didn't sell land () means a cost but then 'saved' capital gains tax
· Assume land sells in year 11 (capital gains tax) after cleanup in year 10
Cost of Capital
Cost of the pipeline
Cost of the building
Opportunity cost of selling land
Saved' capital gains tax on selling land 0
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About this QuestionSTATUS
Sep 21, 2019EXPERT
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