Second Inc. is considering a 6-year project which requires the purchase of a $200,000 machine. This machine will be deprecated at a CCA rate of 30% and be sold for $10,000 when the project ends. Assume there is no CCA recapture or terminal loss. The project is expected to generate earnings before tax and depreciation of $40,000 per year for 6 years. If the project is finance by all equity, the cost of capital would be 12%. The corporate tax rate is 30%. Second only has $40,000 available and needs to borrow the balance at a subsidized rate of 2% which is 4% lower than the market borrowing rate. The bank will charge 10% of the amount borrowed as floatation costs and require Second to repay one third of the loan at year 4 and the remaining balance at year 6.
a. Using the adjusted present value method, determine whether Second should undertake the project.
b. Repeat part a if Second's effective tax rate is zero.