Question

A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,200 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 30% and can depreciate the investment for tax purposes using the five-year MACRS tax depreciation schedule. Suppose the opportunity cost of capital is 8%. 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

Company A	0	1	2	3	4	5
1.Initial investment	-100000
2.After-tax cash inflows		26200	26200	26200	26200	26200
3.Total annual after-tax CFs(1+2)	-100000	26200	26200	26200	26200	26200
4.PV F at 8%(1/1.08^yr.n)	1	0.92593	0.85734	0.79383	0.73503	0.68058
5.PV at 8%(FCF*PV F)(3*4)	-100000	24259.26	22462.277	20798.4	19257.78	17831.28
6.NPV of the project(sum of row 5)	4609.00
7.IRR OF ATCFs(of row 3)	9.73%

Company B	0	1	2	3	4	5	6
1.Initial investment	-100000
2.After-tax cash inflows(26200*(1-30%))		18340	18340	18340	18340	18340
3.Depn. Tax shields(100000*30%*(20%;32%;19.2%;11.52%;11.52% & 5.76%)		6000	9600	5760	3456	3456	1728
4.Total annual after-tax CFs(1+2+3)	-100000	24340	27940	24100	21796	21796	1728
5.PV F at 8%(1/1.08^yr.n)	1	0.92593	0.85734	0.79383	0.73503	0.68058	0.63017
6.PV at 8%(FCF*PV F)(4*5)	-100000	22537.04	23954.047	19131.36	16020.71	14833.99	1088.933
7.NPV of the project(sum of row 6)	-2433.92
8.IRR OF ATCFs(of row 4)	7.05%

b-2. Effective corporate tax rate=

1-(7.05%/9.73%)=

27.54%

Answers (from above workings)
a.NPV of each company
Company A	4609.00
Company B	-2433.92
b-1.IRR
Company A	9.73%
Company B	7.05%
b-2. Effective tax rate	27.54%