Mrs. Lester has the choice between two transactions. Transaction A will generate $175,000 taxable cash flow in the current year (year 0). Transaction B will generate $160,000 cash flow in the current year, but Mrs. Lester will not be required to report $160,000 income for two years (year 2). Mrs. Lester has a 40% marginal tax rate and uses a 9% discount rate to compute NPV. Which of the following statements is true?

Question

Quizplus · Accepted Answer

To determine the best choice between the two options, we need to calculate the NPV for both transactions. 
For transaction A: 
NPV = -175,000 + (175,000/(1+0.09)^1) - (175,000*0.4/(1+0.09)^1) = $20,025

For transaction B: 
NPV = -160,000 + (0/(1+0.09)^1) + (160,000/(1+0.09)^2) - (160,000*0.4/(1+0.09)^1) = $28,744

Based on the calculations, transaction B has a higher NPV ($28,744) compared to transaction A ($20,025). Therefore, Mrs. Lester should choose transaction B because its NPV exceeds transaction A's NPV. The tax cost deferral in Transaction B does not impact Mrs. Lester's NPV calculations.

Mrs Lester Has the Choice Between Two Transactions