Financial Decision Making & Risk Management

Running Head: Change In Tax Evaluation 1

Change In Tax Evaluation 6

Change in Tax Evaluation

Student Name: Manoj Kumar Reddy Koluguri

Westcliff University

Date: 02/28/2021

Initial investment cost

Considering depreciation is on straight line basis and salvage value at year 2 is 50 and year 3, 25. Initial cost of the investment will be: P (initial cost) = salvage value divided by (1-0.25)^0. Therefore its 100 hence revenues100 for each year

Initial cost 100

Cash operating costs 50 yearly

Tax depreciation 33.33

Income pretax 16.67

Tax at 40% for all years =6.67

Net income 10 p.a

After-tax salvage in year 3 15

9. Cash flow in year: 0:-100 year 1:+43.33 year 2:+43.33 year 3: +58.33

Question one.

NPV = (Cash flows)/ (1+r) ^t:

-100 + (43.33)/ (1+20%) + (43.33)/ (1+20%) ^2 + (58.33)/ (1+20%) ^3 =0

NPV at 20% = 0

Question two.

NPV = (Cash flows)/ (1+r) ^t

-100 + (43.33)/ (1+20%) + (43.33)/ (1+20%) ^2 = -33.80

Question three.

100% write off.

Depreciation would not be an individual cash cost, but it impacts a company's net profits and should be taken into account when determining NPV. Zaree et al. (2021) simply deduct the depreciation expense for each cycle from the cash flow. Depreciation doesn't really affect cash flow directly (Ohrn, 2019). It does, however, affect cash management, as it changes tax obligations of the company and decreases operating expenses from taxable income

Effect on year on cash flows

Initial cost of investment 100 Revenue 100 yearly Cash Operating Cost 50 yearly Tax depreciation will be 0 for year one and 33.33 for other years. Income Pretax year1:50, year 2:16.67, year 3:16.67

Tax at 40%year 1,2,3 respectively :20,6.67,6.67 and Net Income for year 1,2,3: will be 30,10,10 with After Tax Saving 15 in year 3. This will result to reduce on year 1 cash flows and the NPV at a rate of 20% with Cash flow of -100, 10, 43.33, and 43.33 for years 0, 1, 2 and 3.

Effects on a) NPV AT20% is a reduced negative NPV

-100 + (10)/ (1+20%) + (43.33)/ (1+20%) ^2 + (43.33)/ (1+20%) ^3

= -36.50

A decrease margin of 36.50

Effect on b) shifts from a viable investment to a loss making investment as result reduced cash flow affected by c

NPV= (Cash flows)/ (1+r) ^t

-100 + (10)/ (1+20%) (43.33)/ (1+20%) ^2

=-61

A decrease margin of 27.20

Question four:

A positive NPV indicates that the project is profitable, an NPV with zero is similar to outflows and a negative one is not beneficial for the lender (Persson, 2019). I conclude it well that the project should finish in year 2 and not 3.

Question five:

Cash flow will increase by 6.67 for all years 1, 2, and 3

a) NPV@20%

-100 + (50)/ (1+20%) + (50)/ (1+20%) ^2 + (65)/ (1+20%) ^3 =-23.57

b) NPV at year 2

-100 + (50)/(1+20%)+(50)/(1+20%)^2 = -23.61

NBV would have a positive significant margin and cash flow will rise annually, but the project will still not be defined as viable.

References

Ohrn, E. (2019). The effect of tax incentives on US manufacturing: Evidence from state accelerated depreciation policies. Journal of Public Economics, 180, 104084.

Persson, M. E. (2019). Asset Values, Depreciation, Profit and Management Information. In Harold Cecil Edey: A Collection of Unpublished Material from a 20th Century Accounting Reformer. Emerald Publishing Limited.

Zaree, M., Kamranrad, R., Zaree, M., & Emami, I. (2020). Project scheduling optimization for contractor’s Net present value maximization using meta-heuristic algorithms: A case study. Journal of Industrial Engineering and Management Studies, 7(2), 36-55.