Question: Able Company has a possible project. It takes an initial investment of $600, and will produce two years of pretax, net cash flow of $1,000
Able Company has a possible project. It takes an initial investment of $600, and will produce two years of pretax, net cash flow of $1,000 each year. Taxes are assessed at 30 percent. The time value of money is 10 percent. We will compute the present value of the project under a variety of circumstances.
- Suppose the $600 initial investment is money that we put aside for working capital. Working capital includes money we use in a cycle to pay vendors while we wait for collections from customers. At the end of the two years, we can recover the $600. The $600 is not deductible for tax purposes and not taxable when we recover it.
Find the present value of the project.
- Suppose the $600 initial investment is investment in equipment that will be depreciated for tax purposes. The depreciation is taken straight line. Thats $300 of depreciation each year.
The net cash in is the $1,000 less taxes paid. Taxes paid are the tax rate x ($1,000 depreciation).
Find the present value of the project.
- Suppose the $600 initial investment is investment in equipment that will be depreciated for tax purposes. The depreciation is taken as accelerated depreciation of $400 in the first year and
$200 in the second year.
The net cash in is the $1,000 less taxes paid. Taxes paid are the tax rate x ($1,000 depreciation).
Find the present value of the project.
- Suppose the $600 initial investment is expensed off entirely in the first year for tax purposes.
The net cash in is the $1,000 less taxes paid. Taxes paid in the first year are tax rate x ($1,000-
$600). Taxes paid in the second year are tax rate x $1,000. Find the present value of the project.
- Fill in the following schedule and comment on why the present value varies across the cells. I know that the difference in present value is small for conditions 2, 3, and 4. Despite the small difference, it illustrates the direction of the effect. Earlier tax deductions increase the present value. The effect would be greater for larger projects that cover more time periods.
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| The initial investment is: | |||
| Setup | 1. Working capital | 2. Depreciated straight line | 3. Depreciated accelerated | 4. Tax deduction entirely in first year |
| Present value |
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