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Ross corporation examines the introduction of a new product. The initial investment is estimated at 20...

Ross corporation examines the introduction of a new product. The initial investment is estimated at 20 million. Furthermore, the net working capital requirements of the project requires are equal to 20%.... Part B Assume that tax authorities decided to shorten depreciation lives for tax purposes. Discuss this would affect the NPV and the IRR of an investment project (assuming all other parameters of the project remain unchanged). (200 words)

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Assume that tax authorities decided to shorten depreciation lives for tax purposes. Discuss this would affect the NPV and the IRR of an investment project

If the life of the assets is shortened for tax purposes, the tax shield on depreciation expense will accrue in earlier years leading to higher NPV and IRR.

Example : Life of asset for tax purposes is assumed to be shortened to 4 years from 5 years in below example, however economic life remains same.

Life 5 years Computation of Net Present Value Discount Rate 10%)Tax Rate ax Depreciation Tax benefit on expense on Total iua: Present Cashflows PV factor Value Cashflows Expense 0 (20,000,000) 01 (4,000,000) Year Depreciation PBT (20,000,000) 1.00 (20,000,000) Initial Investment Net working Capital Net Cash inflow before tax Net Cash inflow before tax Net Cash inflow before tax Net Cash inflow before ta>x Net Cash inflow before tax Recovery of Net working Capital Total 1.00 (4,000,000 1 10,000,0004,000,000 1,400,000 (3,500,000) 7,900,0009181,100 0.826 6,525,400 0.7515,932,900 4 10,000,000 4,000,0001,400,000 (3,500,000) 7,900,000 0.683 5,395,700 S 10,000,000 4,000,0001,400,000 (3,500,000) 7,900,000 0.621 4,905,900 4,000,000 0.621 2,484,000 NPV8,425,000 4.000,000.) 2 10,000,000 3 10,000,000 4,000,000 4,000,000 1,400,000 (3,500,000)7,900,0000 1,400,000 (3,500,000 7,900,000 54,000,000 30,000,000 20,000,000 7,000,000 (17,500,000) 19,500,000 22.2% Life 4 years for tax puroses however economic life remains 5 year Computation of Net Present Value Discount Rate 10%) Tax Rate Depreciation Tax benefit on expense on Total Present Cashflows Expense Depreciation PBT Cashflows PV factor Value (20,000,000)1.00 (20,000,000) (4,000,0001.00 (4,000,000) Initial Investment Net orking Capital Net Cash inflow before tax Net Cash inflow before tax Net Cash inflow before tax Net Cash inflow before tax Net Cash inflow before ta>x Recovery of Net working Capital 0 (20,000,000) 0 (4,000,000) 1 10,000,0005,000,0001,750,000 (3,500,000) 8,250,000 0.909 7,499,250 5,000,000 1,750,000 (3,500,000) 8,250,0000.826 6,814,500 2 10,000,0005 3 10,000,000 5,000000 1,750,000 (3,500,000) 8,250,000 0.751 5,000,000 4 10,000,0005,000,0001,750,00 (3,500,000)8,250,0000.683 5,634,750 0 (3,500,000) 6,500,000 0.621 4,036,500 0.621 2,484,000 5 10,000,000 5 4,000,000 4,000,000 30,000,000 20,000,000 7,000,000 (17,500,000) 19,500,000 NPV 8,664,750

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