PRINCIPLES OF TAXATION F/BUS.+INVEST.
PRINCIPLES OF TAXATION F/BUS.+INVEST.
22nd Edition
ISBN: 9781259917097
Author: Jones
Publisher: MCG
Question
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Chapter 3, Problem 20AP

a.

To determine

Calculate net present value (NPV) and identify the opportunity that Firm E should choose.

a.

Expert Solution
Check Mark

Explanation of Solution

Opportunity 1:

 Step 1: Calculate present value.

 Year 0Year 1Year 2
Before-tax cash flow$(8,000)$5,000$20,000
Less: Tax cost$(3,200)$(2,000)$(8,000)
After-tax cash flow$4,800$3,000$12,000
Multiply: Discount factor at 5%-× 0.952× 0 .907
Present value$(4,800)$2,856$10,884

Working note:

Calculate tax cost.

 Year 0Year 1Year 2
Taxable income$8,000$5,000$20,000
Multiply: Marginal tax rate× 0.40× 0 .40× 0 .40
Tax cost$3,200$2,000$8,000

Step 2: Calculate NPV.

NPV = (Present value of Year 0+ Present value of Year 1+ Present value of Year 2)=($4,800+$2,856+$10,884)=$8,940

Opportunity 2:

Step 1: Calculate present value.

 Year 0Year 1Year 2
Before-tax cash flow$6,000$5,000$5,000
Less: Tax cost$(2,400)$(2,000)$(2,000)
After-tax cash flow$3,600$3,000$3,000
Multiply: Discount factor at 5%-× 0.952× 0 .907
Present value$3,600$2,856$2,721

Working note:

Calculate tax cost.

 Year 0Year 1Year 2
Taxable income$6,000$5,000$5,000
Multiply: Marginal tax rate× 0.40× 0 .40× 0 .40
Tax cost$2,400$2,000$2,000

Step 2: Calculate NPV.

NPV = (Present value of Year 0+ Present value of Year 1+ Present value of Year 2)=($3,600+$2,856+$2,721)=$9,177

The value of net present value (NPV) of Opportunity 2 is greater than Opportunity 1. Hence, Firm E should choose Opportunity 2.

b.

To determine

Calculate net present value (NPV) and identify the opportunity that Firm E should choose.

b.

Expert Solution
Check Mark

Explanation of Solution

Opportunity 1:

 Step 1: Calculate present value.

 Year 0Year 1Year 2
Before-tax cash flow$(8,000)$5,000$20,000
Less: Tax cost$(1,200)$(750)$(3,000)
After-tax cash flow$6,800$4,250$17,000
Multiply: Discount factor at 5%-× 0.952× 0 .907
Present value$(6,800)$4,046$15,419

Working note:

Calculate tax cost.

 Year 0Year 1Year 2
Taxable income$8,000$5,000$20,000
Multiply: Marginal tax rate× 0.15× 0 .15× 0 .15
Tax cost$1,200$750$3,000

Step 2: Calculate NPV.

NPV = (Present value of Year 0+ Present value of Year 1+ Present value of Year 2)=($6,800+$4,046+$15,419)=$12,665

Opportunity 2:

Step 1: Calculate present value.

 Year 0Year 1Year 2
Before-tax cash flow$6,000$5,000$5,000
Less: Tax cost$(900)$(750)$(750)
After-tax cash flow$5,100$4,250$4,250
Multiply: Discount factor at 5%-× 0.952× 0 .907
Present value$5,100$4,046$3,855

Working note:

Calculate tax cost.

 Year 0Year 1Year 2
Taxable income$6,000$5,000$5,000
Multiply: Marginal tax rate× 0.15× 0 .15× 0 .15
Tax cost$900$750$750

Step 2: Calculate NPV.

NPV = (Present value of Year 0+ Present value of Year 1+ Present value of Year 2)=($5,100+$4,046+$3,855)=$13,001

The value of net present value (NPV) of Opportunity 2 is greater than Opportunity 1. Hence, Firm E should choose Opportunity 2.

c.

To determine

Calculate net present value (NPV) and identify the opportunity that Firm E should choose.

c.

Expert Solution
Check Mark

Explanation of Solution

Opportunity 1:

 Step 1: Calculate present value.

 Year 0Year 1Year 2
Before-tax cash flow$(8,000)$5,000$20,000
Less: Tax cost$(3,200)$(750)$(3,000)
After-tax cash flow$4,800$4,250$17,000
Multiply: Discount factor at 5%-× 0.952× 0 .907
Present value$(4,800)$4,046$15,419

Working note:

Calculate tax cost.

 Year 0Year 1Year 2
Taxable income$8,000$5,000$20,000
Multiply: Marginal tax rate× 0.40× 0 .15× 0 .15
Tax cost$3,200$750$3,000

Step 2: Calculate NPV.

NPV = (Present value of Year 0+ Present value of Year 1+ Present value of Year 2)=($4,800+$4,046+$15,419)=$14,665

Opportunity 2:

Step 1: Calculate present value.

 Year 0Year 1Year 2
Before-tax cash flow$6,000$5,000$5,000
Less: Tax cost$(2,400)$(750)$(750)
After-tax cash flow$3,600$4,250$4,250
Multiply: Discount factor at 5%-× 0.952× 0 .907
Present value$3,600$4,046$3,855

Working note:

Calculate tax cost.

 Year 0Year 1Year 2
Taxable income$6,000$5,000$5,000
Multiply: Marginal tax rate× 0.40× 0 .15× 0 .15
Tax cost$2,400$750$750

Step 2: Calculate NPV.

NPV = (Present value of Year 0+ Present value of Year 1+ Present value of Year 2)=($3,600+$4,046+$3,855)=$11,501

The value of net present value (NPV) of Opportunity 1 is greater than Opportunity 2. Hence, Firm E should choose Opportunity 1.

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Chapter 3 Solutions

PRINCIPLES OF TAXATION F/BUS.+INVEST.

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