CNCC Tax Valuation Project Question

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fcbbegul

Engineering

Colorado Northwestern Community College

Description


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:

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%

  1. Please verify that the information given above yields NPV = 0.
  2. If you decide to terminate the project in year two (2) what would be the NPV of the project? 
  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? 
  4. Would it now make sense to terminate the project after two rather than three years?
  5. How would your answers change if the corporate income tax were abolished entirely?


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Explanation & Answer

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Running Head: Change In Tax Evaluation

Change in Tax Evaluation
Student Name
Institution Affiliation

1

Change In Tax Evaluation

2

Initial investment cost
Considering depreciation is on straight line basis and salvage value at year 2 is 50 and year 3, 25.
Initial cost of the investment will be: P (initial cost) = salvage value divided by (1-0.25)^0.
Therefore its 100 hence revenues100 for each year
Initial cost 100
Cash operating costs 50 yearly
Tax depreciation 33.33
Income pretax 16.67
Tax at 40% for all years =6.67
Net income 10 p.a
After-tax salvage in year 3 15
9. Cash flow in year: 0:-100 year 1:+43.33 year 2:+43.33 year 3: +58.33
Question one.
NPV = (Cash flows)/ (1+r) ^t:
-100 + (43.33)/ (1+20%) + (43.33)/ (1+20%) ^2 + (58.33)/ (1+20%) ^3 =0
NPV at 20% = 0

Question two.
NPV = (Cash flows)/ (1+r) ^t

Change In Tax Evaluation

3

-100 + (43.33)/ (1+20%) + (43.33)/ (1+20%) ^2 = -33.80

Question three.
100% write off.
Depreciation would not be an individual cash cost, but it impacts a company's net profits and
should be taken into account when determining NPV. Zaree et al. (2021) simply deduct the
depreciation expense for each cycle from the cash flow. Depreciation doesn't really affect cash
flow directly (Ohrn, 2019). It does, however, affect cash management, as it changes tax
obligations of the company and decreases operating expenses from taxable income
Effect on year on cash flows

Initial cost of investment 100
Revenue 100 yearly
Cash Operating Cost 50 yearly
Tax depreciation will be 0 for year one and 33.33 for other years.
Income Pretax year1:50, year 2:16.67, year 3:16.67

Tax at 40%year 1,2,3 respectively :20,6.67,6.67 and Net Income for year 1,2,3: will be 30,10,10
with After Tax Saving 15 in year 3. This will result to reduce on year 1 cash flows and the NPV at
a rate of 20% with Cash flow of -100, 10, 43.33, and 43.33 for years 0, 1, 2 and 3.
Effects on a) NPV AT20% is a reduced n...


Anonymous
I was having a hard time with this subject, and this was a great help.

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