Chapter 7C, Problem 7C.5P

Income Taxes and Net Present Value Analysis LO7—5, L07—B

Shimano Company has an opportunity to manufacture and sell one of two new products for a five-year period. The company’s tax rate is 30% and its after-tax cost of capital is 14%. The cost and revenue estimates for each product are as follows:

Required:

1. Calculate the annual income tax expense for each of Years 1 through 5 that will arise if Product A is introduced.
2. Calculate the net present value of the investment opportunity pertaining to Product A.
3. Calculate the annual income tax expense for each of Years 1 through 5 that will arise if Product B is introduced.
4. Calculate the net present value of the investment opportunity pertaining to Product B.
5. Calculate the project profitability index for Product A and Product B. Which of the two products should the company pursue? Why?