The Minister of Finance is reviewing the depreciation regulations. Currently the Canadian Income Tax Act requires that intangible assets, such as franchises, patents and copyrights, be depreciated on a straight-line basis. The maximum annual deprecation charge is calculated by fully depreciating the intangible asset over seven years. The Minister is considering changing this to be consistent with all other assets and simply having a CCA class for intangible assets with a CCA rate of 75%. The Minister has asked you to determine the effect that this change would have on a start-up engineering company with a valuable patent. Consider a patent that cost $700 000 to establish. As with many start-up engineering companies, assume that the new company will not be profitable in the first year but expect profitability thereafter. Given that the start-up company has an income tax rate of 30% and an after-tax cost of capital of 15%, what is the after-tax cost of this patent under both approaches? Which one is the most favourable to a start-up engineering company? (Assume that the company will retain the patent for a very long time.)
The Minister of Finance is reviewing the depreciation regulations. Currently the Canadian Income Tax Act requires that intangible assets, such as franchises, patents and copyrights, be depreciated on a straight-line basis. The maximum annual deprecation charge is calculated by fully depreciating the intangible asset over seven years. The Minister is considering changing this to be consistent with all other assets and simply having a CCA class for intangible assets with a CCA rate of 75%. The Minister has asked you to determine the effect that this change would have on a start-up engineering company with a valuable patent. Consider a patent that cost $700 000 to establish. As with many start-up engineering companies, assume that the new company will not be profitable in the first year but expect profitability thereafter. Given that the start-up company has an income tax rate of 30% and an after-tax cost of capital of 15%, what is the after-tax cost of this patent under both approaches? Which one is the most favourable to a start-up engineering company? (Assume that the company will retain the patent for a very long time.)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:The Minister of Finance is reviewing the depreciation regulations. Currently the Canadian
Income Tax Act requires that intangible assets, such as franchises, patents and copyrights, be
depreciated on a straight-line basis. The maximum annual deprecation charge is calculated by
fully depreciating the intangible asset over seven years. The Minister is considering changing
this to be consistent with all other assets and simply having a CCA class for intangible assets
with a CCA rate of 75%. The Minister has asked you to determine the effect that this change
would have on a start-up engineering company with a valuable patent. Consider a patent that
cost $700 000 to establish. As with many start-up engineering companies, assume that the new
company will not be profitable in the first year but expect profitability thereafter. Given that
the start-up company has an income tax rate of 30% and an after-tax cost of capital of 15%,
what is the after-tax cost of this patent under both approaches? Which one is the most
favourable to a start-up engineering company? (Assume that the company will retain the patent
for a very long time.)
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