![7. A potential project requires an initial investment of $100,000 and is expected to produce revenues less costs (R - C) of $26,000 per year for 5 years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future (Company A will also not benefit fronm depreciation deductions). Company B pays corporate taxes at a rate of 35% and can depreciate the investment for tax purposes using the 3-year MACRS tax depreciation schedule. Assume investors demand an 8% return on capital from both companies investment has no salva projects NPV for each company. for the project, no working capital is required, and the ec e the o eY-T].PT D Hint: NPV(Company A)-Investment+PV( (R - C)) NPV(Company B) =-Investment + PV[ (R-C)(1-Tc) ] + PV(Tc Depr) a. NPV(Company A)-32,523; NPV(Company B) -2,363 b. NPV(Company A) 3,810; NPV(Company B) -4,127 c. NPV(Company A) 3,810; NPV(Company B) -2,363 d. NPV(Company A)--32,523; NPV(Company B)4,127](http://img.homeworklib.com/questions/50ec09f0-7543-11ea-910b-419add502189.png?x-oss-process=image/resize,w_560)
Homework Answers
Net present value calculation for Company A and Company B:
| Year (n) | Cash flow from Company A (CF) | Present value (PV) of Cash Flows at the discount rate of 8% | Formula used |
| 0 | -$100,000 | -$100,000 | CF/(1+8%)^0 |
| 1 | $26,000 | $24,074 | CF/(1+8%)^1 |
| 2 | $26,000 | $22,291 | CF/(1+8%)^2 |
| 3 | $26,000 | $20,640 | CF/(1+8%)^3 |
| 4 | $26,000 | $19,111 | CF/(1+8%)^4 |
| 5 | $26,000 | $17,695 | CF/(1+8%)^5 |
| Net Present Value (NPV) | $3,810 | sum of above values |
| Company B | |||||||||
| Year (n) | Initial Investments | 3-year MACRS depreciation percentage | Depreciation with MACRS Method (D) | Gross Income (R-C) | Taxable Income (Gross income - depreciation) | Income taxes (Taxable Income *35%) | After Tax Net Income (taxable income - taxes) | Free Cash Flow = ( Net Income + depreciation) | Present Value @8% discount rate= FCF/ (1+8%)^n |
| 0 | -$100,000 | -$100,000 | -$100,000 | ||||||
| 1 | 33.33% | $33,330 | $26,000 | -$7,330 | -$2,566 | -$4,765 | $28,566 | $26,450 | |
| 2 | 44.45% | $44,450 | $26,000 | -$18,450 | -$6,458 | -$11,993 | $32,458 | $27,827 | |
| 3 | 14.81% | $14,810 | $26,000 | $11,190 | $3,917 | $7,274 | $22,084 | $17,531 | |
| 4 | 7.41% | $7,410 | $26,000 | $18,590 | $6,507 | $12,084 | $19,494 | $14,328 | |
| 5 | $26,000 | $26,000 | $9,100 | $16,900 | $16,900 | $11,502 | |||
| Net Present value (NPV) | -$2,363 | ||||||||
| For Negative cash flow, a tax credit is assumed | |||||||||
Therefore correct answer is option c. NPV (Company A) = 3,810; NPV (Company B) = -2,363
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