A project requires an initial investment of $200,000 and is expected to produce a cash flow before taxes of 120,000 per year for two years. [i.e. cash flows will occur at t = 1 and t =
2]) The corporate tax rate is 30%. The assets will be depreciated using MACRS - 3 year schedule: (t=1, 33%); (t = 2: 45%); (t = 3: 15%); (t = 4: 7%). The company's tax situation is such that it can make use of all applicable tax shields. The opportunity cost of capital is 12%. Assume that the asset can be sold for book value. Calculate the NPV of the project: (Approximately)
A) $22,463
B) $19,315
C) $16,244
D) None of the above

Question

Quizplus · Accepted Answer

Step 1: Calculate the annual depreciation expense using the MACRS schedule
Year 1: $200,000 * 33% = $66,000
Year 2: $200,000 * 45% = $90,000
Year 3: $200,000 * 15% = $30,000
Year 4: $200,000 * 7% = $14,000

Step 2: Calculate the annual taxable income
Year 1: $120,000 - $66,000 = $54,000
Year 2: $120,000 - $90,000 = $30,000

Step 3: Calculate the annual taxes
Year 1: $54,000 * 30% = $16,200
Year 2: $30,000 * 30% = $9,000

Step 4: Calculate the annual after-tax cash flows
Year 1: $120,000 - $16,200 - $66,000 = $37,800
Year 2: $120,000 - $9,000 - $90,000 = $21,000

Step 5: Calculate the salvage value
Salvage value = Book value = $0 (since the asset will be sold for book value)

Step 6: Calculate the NPV
NPV = - $200,000 + ($37,800 / (1 + 0.12)^1) + ($21,000 / (1 + 0.12)^2) + ($30,000 / (1 + 0.12)^3) + ($14,000 / (1 + 0.12)^4)
NPV = $19,315

Therefore, the best choice is B.

A Project Requires an Initial Investment of $200,000 and Is