One measure of the effective tax rate is the difference between the IRRs of pretax and after-tax cash flows, divided by the pretax IRR. Consider, for example, an investment I generating a perpetual stream of pretax cash flows C. The pretax IRR is C /I, and the after-tax IRR is C − TC)/I, where TC is the statutory tax rate. The effective rate, call it T E, is
In this case the effective rate equals the statutory rate.
a. Calculate T E for the guano project in Section 6.2.
b. How does the effective rate depend on the tax depreciation schedule? On the inflation
rate?
c. Consider a project where all of the up-front investment is treated as an expense for tax purposes. For example, R&D and marketing outlays are always expensed in the United States. They create no tax depreciation. What is the effective tax rate for such a project?
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