Question:
A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,000 per year for 5 years. Company (A) has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company (B) pays corporate taxes at a rate of 35% and can depreciate the investment for tax purposes using the 5 year MACRS tax depreciation schedule. Suppose the opportunity cost of capital is 8%. Ignore inflation.
Q1. Calculate project NPV for each company.
Q2. What is the IRR (internal rate of return) of the after tax cash flows for each company? What does comparison of the IRR's suggest is the effective corporate tax rate?