Needco Supplies-Canada employee Stella Needleson was asked to determine if the current process of dying writing paper should be retained or a new, environment friendly process should be implemented. Estimates or actual values for the two processes are summarized below. She performed an after-tax replacement analysis at 10% per year and the corporation’s effective tax rate of 32% to determine that economically, the new process should be chosen. Was she correct? Why or why not? (Note: Canadian tax law does not impose the half-year convention requirement. Monetary units are in Canadian dollars.)

Question

Answer 1

Defender

Original life estimate was 12 years.

Annual SL depreciation = 450,000 /12 = $37,500

Annual tax savings = (37,500 + 160,000)(0.32) = $63,200

AWD = -50,000(A/P,10%,5) – 160,000 + 63,200
= -50,000(0.2638) – 96,800
= $–109,990
Challenger

Book value of D = 450,000 – 7(37,500)
= $187,500

CL from sale of D = BV7 – Market value
= 187,500 – 50,000
= $137,500

Tax savings from CL, year 0 = 137,500(0.32)
= $44,000

Challenger annual SL depreciation = 700,000 – 50,000
10
= $65,000

Annual tax savings = (65,000 +150,000)(0.32)
= $68,800

Challenger DR when sold in year 8 = $0

AWC = (–700,000 + 44,000)(A/P,10%,10) + 50,000(A/F,10%,10) – 150,000 + 68,800
= –656,000(0.16275) + 50,000(0.06275) – 81,200
= $-184,827

Select the defender. Decision was incorrect since D has a lower AW value of costs.