Chapter 3, Problem 2TPC

Firm D is considering investing $400,000 cash in a three-year project with the following cash flows:

Under each of the following assumptions, determine if Firm D should make the investment. In each case, use a 10 percent discount rate to compute NPV.

1. a.      The revenue is taxable, the expenses are deductible, and the marginal tax rate is 15 percent.
2. b.      The revenue is taxable, the expenses are deductible, and the marginal tax rate is 40 percent.
3. c.       The revenue is taxable, only one-half of the expenses are deductible, and the marginal tax rate is 15 percent.
4. d.      Firm D can deduct the expenses in the year paid (against other sources of income) but can defer recognizing the $180,000 total income until year 2. (It will collect the revenues as indicated in years 0, 1, and 2 so that before-tax cash flows don’t change.) The marginal tax rate is 40 percent.