Taxpayer is considering the following investment. Year 1 Year 2 Year 3 Year 4 Year 5...

Taxpayer is considering the following investment.

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Cash income produced	4,000	11,000	20,000	23,000	25,000	30,000
Cash expenses	1,000	5,000	6,000	8,000	8,000	10,000
Expenses that are tax deductible	None	80%	70%	80%	100%	75%
Marginal tax rate	20%	24%	24%	30%	30%	30%

Compute the present value of the after-tax cash flows of this investment, using a discount rate of 6%. Note: This investment begins with year 1, not year 0. Your cash flows should be discounted accordingly.

Solutions

Expert Solution

As the investment begins in Year 1, not Year 0, this is an Annuity due where payments occur at the beginning of each period.

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Income	$4,000	$11,000	$20,000	$23,000	$25,000	$30,000
Expenses	0	$4,000 ($5,000*80%)	$4,200 ($6,000*70%)	$6,400 ($8,000*80%)	$8,000 ($8,000*100%)	$7,500 ($10,000*75%)
Profit	$4,000	$7,000	$15,800	$16,600	$17,000	$22,500
Marginal tax rate	20%	24%	24%	30%	30%	30%
Tax on profits	$800 ($4,000*20%)	$1,680 ($7,000*24%)	$3,792 ($15,800*24%)	$4,980 ($16,600*30%)	$5,100 ($17,000*30%)	$6,750 ($22,500*30%)
After tax cash flow	$3,200	$5,320	$12,008	$11,620	$11,900	$15,750
PVAF	1	0.943	0.890	0.840	0.792	0.747
Present value of after tax cash flows	$3,200 ($3,200*1)	$5,016.76 ($5,320*0.943)	$10,687.12 ($12,008*0.890)	$9,760.8 ($11,620*0.840)	$9,424.8 ($11,900*0.792)	$11,765.25 ($15,750*0.747)

Present value of the after-tax cash flows of this investment = $3,200 + $5,016.76 + $10,687.12 + $9,760.8 + $9,424.8 + $11,765.25

= $49,854.73

ekkarill92 answered 1 year ago

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