Question

1. Mr. Hewitt is deciding between two investment opportunities: Investment A and Investment B. Both investments will require an initial nondeductible cash outlay of $100,000 in 2020 (the current year). Other relevant details on each investment are as follows: • Investment A will provide Mr. Hewitt with annual pretax income of $14,000 in each of the following three years: 2021, 2022, and 2023. This income will be taxable to Mr. Hewitt at his ordinary income tax rate of 35%. Mr. Hewitt can then recover his initial investment of $100,000 in 2023 tax-free. Mr. Hewitt must also pay a non-deductible investment advisory fee of $500 per year in 2021, 2022, and 2023 to maintain Investment A. o • Investment B will not provide any annual income to Mr. Hewitt after he makes his initial investment. However, Mr. Hewitt can sell Investment B in 2023 for $130,000. Any gain on this sale will be taxed at Mr. Hewitt's long-term capital gains tax rate of 15%. Assuming a discount rate of 7%, which investment maximizes the NPV of Mr. Hewitt's post-tax investment income - and by how much? Support your answer with clearly labeled calculations.

My work is below: I got part A but was a little confused on part B!

Answer 1

Investment B:

Initial investment = $100,000
Total Sale Value at the end of 2023 = $130,000
Therefore, total pre-tax gain = 30,000
Long term gains Tax @ 15% on the above gain = 30000 * 15% = 4500

Therefore, Net Realized at end of 2023 = $125,500
Present value of Net Realized = 125500 / (1.07)^3 = $102,445.38

Therefore, NPV of Investment B = $2,455.38

From the above it is clear that Investment A yields maximum NPV of $4,661