Question

Firm X has the opportunity to invest $254,000 in a new venture. The projected cash flows from the venture are as follows. Use Appendix A and Appendix B. Please show all calculations.

	Year 0				Year 1				Year 2				Year 3
Initial investment	$	(254,000	)
Revenues					$	38,400			$	38,400			$	38,400
Expenses						(23,040	)			(5,760	)			(5,760	)
Return of investment														254,000
Before-tax net cash flow		(254,000	)		$	15,360			$	32,640			$	286,640

Firm X uses an 8 percent discount rate, and its marginal tax rate over the life of the venture will be 20 percent.

1. a-1. Complete the below table to calculate NPV. Assume that the revenues are taxable income, and the expenses are deductible.
2. a-2. Should firm X make the investment?
3. b-1. Complete the below table to calculate NPV. Assume that the revenues are taxable income, but the expenses are nondeductible.
4. b-2. Should firm X make the investment?

Answer 1

							8.00%
Year	Capital investment	Revenue	Expense	Total income	Tax @ 20% on total income	Cash Flow=Capital investment + Income less taxes	PV factor = 1/ (1+r)^t	PV
0	$             (254,000)					$      (254,000)	1.000	$(254,000.00)
1		$                 38,400	$               (23,040)	$                 15,360	$                  (3,072)	$          12,288	0.926	$    11,377.78
2		$                 38,400	$                  (5,760)	$                 32,640	$                  (6,528)	$          26,112	0.857	$    22,386.83
3	$               254,000	$                 38,400	$                  (5,760)	$                 32,640	$                  (6,528)	$        280,112	0.794	$ 222,361.94
							NPV	$      2,126.55
Since NPV is positive, the investment should be done
							8.00%
Year	Capital investment	Revenue	Expense		Tax @ 20% on total revenue	Cash Flow=Capital investment + Revenue less expense less taxes	PV factor = 1/ (1+r)^t	PV
0	$             (254,000)					$      (254,000)	1.000	$(254,000.00)
1		$                 38,400	$               (23,040)		$                  (7,680)	$            7,680	0.926	$      7,111.11
2		$                 38,400	$                  (5,760)		$                  (7,680)	$          24,960	0.857	$    21,399.18
3	$               254,000	$                 38,400	$                  (5,760)		$                  (7,680)	$        278,960	0.794	$ 221,447.44
							NPV	$     (4,042.27)
Since NPV is negative, the investment should not be accepted.