Make sense to terminate the project after two rather three

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Reference no: EM132659655

Taxes are costs, and, therefore, changes in tax rates can affect consumer prices, project lives and the value of existing firms. Evaluate the change in taxation on the valuation of the following project:

 

 

 

1

2

3

1.Initial Investment

 

100

 

 

 

2. Revenues

 

 

100

100

100

3. Cash operating costs

 

 

50

50

50

4. Tax depreciation

 

 

33.33

33.33

33.33

S. Income pretax

 

 

16.67

16.67

16.67

6. Tax at 40%

 

 

6.67

6.67

6.67

7. Net income

 

 

10

10

10

8. After-tax salvage

 

 

 

 

15

9. Cash flow (7 + 8 + 4

- 1)

-100

+43.33

+43.33

+58.33

NPV at 20%. 0

 

 

 

 

 

Assumptions: Tax depreciation is straight-line over three years. Pre-tax salvage value is 25 in year 3 and 50 if the asset is scrapped in year 2. Tax on salvage value is 40% of the difference between salvage value and book value of the investment. The cost of capital is 20%

Question 1: verify that the information given above yields NPV = 0.

Question 2: If you decide to terminate the project in year two (2) what would be the NPV of the project?

Question 3: Suppose that the government now changes tax depreciation to allow a 100% write-off in year one (1). How does this affect your answers to parts a and b above?

Question 4: Would it now make sense to terminate the project after two rather than three years?

Question 5: How would your answers change if the corporate income tax were abolished entirely?

Reference no: EM132659655

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