Share
Explore BrainMass

Depreciation tax shields

I need help with the following problems using the cash flow information for Project A and B. File also attached.

Use the following project cash flow information for questions 23 through 27.

Project A Project B
Initial Investment 100,000 100,000
Year 1 40,000 10,000
Year 2 40,000 10,000
Year 3 40,000 75,000
Year 4 40,000 85,000

23. If the discount rate is 7%, which of the following is true:

a. The firm should accept only project A
b. The firm should accept only project B
c. The firm should accept both projects A and B
d. The firm should accept neither project A or B

24. If the discount rate is 10% and the projects are mutually exclusive, which of the following is true:

a. The firm should accept only project A
b. The firm should accept only project B
c. The firm should accept both projects A and B
d. The firm should accept neither project A or B

25. At what rate of interest is the present value of Project A equal to (within $100) the present value of Project B?

a. 20%
b. 0%
c. 15%
d. None of these.

26. If the discount rate is 25% and the projects are not mutually exclusive, which of the following is true:

a. The firm should accept only project A
b. The firm should accept only project B
c. The firm should accept both projects A and B
d. The firm should accept neither project.

27. What effect would depreciation have on the projects selection criteria:

a. Since the initial investment is equal for the two projects, Depreciation tax shields would add equally to both projects, ensuring no change in project acceptance criteria at all interest rates.
b. At lower interest rates, the effect of depreciation will tend to favor project A over project B.
c. If the projects are mutually exclusive, the computation of depreciation tax shields will have no effect on selection, regardless of the size of the initial investment.
d. None of these is true.

Attachments

Solution Preview

Use the following project cash flow information for questions 23 through 27.

Project A Project B
Initial Investment -100,000 -100,000
Year 1 40,000 10,000
Year 2 40,000 10,000
Year 3 40,000 75,000
Year 4 40,000 85,000

Cost of Capital 7% 7%

NPV= $35,488.45 $44,148.62

1 If the discount rate is 7%, which of the following is true:

a. The firm should accept only project A
b. The firm should accept only project B
c. The firm should accept both projects A and B
d. The firm should accept neither project A or B

c. The firm should accept both projects A and B

As both the firms are having positive NPVs.

2 If the discount rate is 10% and the projects are ...

Solution Summary

Depreciation tax shields are assessed.

$2.19