Question

A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $27,300 per year for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company B pays corporate taxes at a rate of 40% and can depreciate the investment for tax purposes using the five-year MACRS tax depreciation schedule. Suppose the opportunity cost of capital is 10%. Ignore inflation.

a. Calculate project NPV for each company. (Negative answers should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest whole dollar amount.)

	NPV
Company A	$
Company B	$

b-1. What is the IRR of the after-tax cash flows for each company? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

	IRR
Company A	$ %
Company B	$ %

b-2. What does comparison of the IRRs suggest is the effective corporate tax rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

Effective tax rate             %

Answer 1

a: NPV

Company A = $3488.48

Company B = $ -8277.04

b-1 IRR

Company A = 11.36%

Company B = 6.57%

b2 Effective tax rate = 1- 0.0657/0.1136 = 42.2%

Cash flow data as below

Year	Company A
	Cash flows
0	-100000
1	27300
2	27300
3	27300
4	27300
5	27300
NPV	3488.48
IRR	11.36%

Year	Company B
	Initial cost	Cash inflows after tax	Tax shield	Net Cash flow
0	-100000			-100000
1		16380	8000	24380
2		16380	12800	29180
3		16380	7680	24060
4		16380	4608	20988
5		16380	4608	20988
			NPV	-8277.04
			IRR	6.57%

Tax shield = Tax rate*Initial cost* depreciation rate

Calculations