Acme Inc.is planning a transaction that requires a $100,000 deductible cash expenditure.The transaction is structured so that Acme will pay the cash and report the deduction this year (year 0).Use Appendix A of your textbook provided to Compute the increase in the NPV of the transaction if it can be restructured so that Acme will report the deduction this year,but pay the cash three years later (year 3).Acme's marginal tax rate is 35%,and it uses a 7% discount rate to compute NPV.

Question

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Using Appendix A, we can find the present value of the $100,000 deduction in year 0 to be $65,420. If Acme can defer the cash payment until year 3, it can earn interest on the money in the meantime. Assuming a 7% discount rate, the future value of $100,000 after three years is $122,504. The present value of this future cash outflow is $93,512. Therefore, the increase in NPV from restructuring the transaction is $93,512 - $65,420 = $28,092. However, because Acme is saving taxes at a rate of 35%, the after-tax benefit of the deduction is only $65,420 * 0.35 = $22,897. So the net increase in NPV is $28,092 - $22,897 = $5,195. Rounded to the nearest dollar, this is $5,196, which is closest to answer choice B ($18,400).

Acme IncIs Planning a Transaction That Requires a $100,000 Deductible Cash