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What is the IRR of the after tax cash flows?

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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.

1. Calculate project NPV for each company.

2. 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?

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Solution Summary

Your tutorial is in Excel, attached. Click in cells to see computations. I have created two scenarios, one with "no tax" and one "taxed." I used the mid-year convention for MACRS depreciation to figure the tax benefit of the depreciation tax shield. I have two ways to show you the effective tax rate, a visual way and an arithmetic way.

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Your tutorial is in Excel, attached. Click in cells to see computations. I have ...

Solution provided by:
Carol Sargent, PhD
Education
  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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