A project will cost $20,000 and is expected to return $22,000 next year. Your marginal tax rate is 30%. One-year taxable bonds that have similar risk to the project are yielding 9%.
Similar-risk municipal bonds are yielding 6%. What is the NPV of this project? Round your
Answer to the nearest dollar.

Question

Quizplus · Accepted Answer

First, we need to calculate the net cash flows:
Net cash flow = Return - Cost(1 - Tax rate)
Net cash flow = $22,000 - $20,000(1 - 0.30)
Net cash flow = $22,000 - $14,000
Net cash flow = $8,000
Next, we need to calculate the NPV using both taxable and municipal bond rates:
NPV(taxable) = -$20,000 + ($8,000 / 1.09) = -$367.43
NPV(municipal) = -$20,000 + ($8,000 / 1.06) = $131.58
Since the NPV is positive with the municipal bond rate and negative with the taxable bond rate, we should choose the municipal bond rate. Therefore, the best choice is B.

A Project Will Cost $20,000 and Is Expected to Return