Ms. Card bought an investment that will generate the following cash flows over a three-year period. If Ms. Card's marginal tax rate over the three year period is 40% and she uses a 6% discount rate, compute the NPV of the transaction.

Question

Ms. Card bought an investment that will generate the following cash flows over a three-year period.  If Ms. Card's marginal tax rate over the three year period is 40% and she uses a 6% discount rate, compute the NPV of the transaction.

Quizplus · Accepted Answer

To calculate NPV, we need to discount each cash flow at a rate of 6% and then sum them up. 
Year 1: 15,000/(1+0.06)^1 = $14,150.94
Year 2: 18,000/(1+0.06)^2 = $15,663.50
Year 3: 20,000/(1+0.06)^3 = $16,969.03

NPV = -22,500 + $14,150.94 + $15,663.5 + $16,969.03 = $84,964.47

Since Ms. Card's marginal tax rate is 40%, we assume that she will pay taxes on the cash flows received. However, the problem does not provide us with any information on the tax treatment of the investment, such as whether it generates interest income or capital gains. Hence, we cannot adjust the cash flows for taxes and will use the pretax cash flows to calculate NPV.

Ms Card Bought an Investment That Will Generate the Following