Question

Corporation VB was formed in 2019. Immediately prior to year-end, VB is considering a $500,000 deductible expenditure. It can either make the expenditure before the end of 2019, or wait until 2020. However, if it waits the cost of the expenditure will increase to $525,000. Before considering this expenditure, VB has the following projected pre-tax cash flows and taxable income for 2019, 2020, and 2021. Use Appendix A. Taxable income and pre-tax cashflow 2019 $ 120,000 1000 2020 $400,000 2021 $ 700,000 a. Using a 5 percent discount rate, compute the NPV of VB's after-tax cash flows if the expenditure is in 2019. b. Using a 5 percent discount rate, compute the NPV of VB's after-tax cash flows if the expenditure is in 2020. c. Based on your calculations, when should VB make this expenditure?

(Round discount factors to 3 decimal places. Round intermediate calculations and final answers to the nearest whole dollar amount.)

Answer 1

	a.
		Year	Year	Taxable income and pre tax cashflow	Deductible expenditure	Total cash flow	Present value factor@5%	Present value of cash flow
		A	B	C	D	E=C+D	F=1/(1+5%)^A	G=E*F
		1	2019	120,000	(500,000)	620,000	0.952	590,476
		2	2020	400,000		400,000	0.907	362,812
		3	2021	700,000		700,000	0.864	604,686
							Net present value	1,557,974
	b.
		Year	Year	Taxable income and pre tax cashflow	Deductible expenditure	Total cash flow	Present value factor@5%	Present value of cash flow
		A	B	C	D	E=C+D	F=1/(1+5%)^A	G=E*F
		1	2020	400,000	(525,000)	925,000	0.952	880,952
		2	2021	700,000		700,000	0.907	634,921
							Net present value	1,515,873
	c.	Based on the above calculation the VB should make the expenditure in the year 2019 as net present value is higher if VB invests in 2019