Change In Tax Evaluation 6 Change in Tax Evaluation Student Name: ✓ Solved

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 . 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 + (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.

Paper For Above Instructions

The evaluation of tax changes, investments, and their implications for net present value (NPV) is critical for financial decision-making in businesses. Understanding these concepts can help companies make informed decisions about whether to pursue investment opportunities or not. This paper outlines detailed evaluations regarding investment analysis, depreciation implications, and NPV calculations.

Tax evaluation begins with understanding the initial investment cost. The initial investment is often affected not only by the purchase price but also by how depreciation is accounted for over time. Depreciation can significantly lower taxable income, which in turn affects a company's cash flow and NPV (Ohrn, 2019). Straight-line depreciation is a common method that allocates an equal amount of expense each year over the asset's useful life. In the scenario described, the initial investment was framed at $100 (the salvage value divided by (1-0.25)^0) and an operating cost of $50 per year resulted in taxable income that led to a net income of $10 per annum after accounting for high depreciation costs.

The first question involves calculating the NPV, a crucial performance metric for capital budgeting. The cash flow from the investment shows negative cash outflows during the initial period, which gradually transitions to positive cash inflows. The NPV formula, illustrated by the calculation of cash flows discounted at a 20% rate, yielded an NPV of 0, indicating a break-even point. This analysis reveals the investment can be deemed acceptable if the discount rate remains low enough (Zaree et al., 2021).

Further evaluation of the cash flows highlighted how a 100% write-off for depreciation can benefit the valuation. Although depreciation does not impact cash flow directly, it influences a company’s net income and thus tax obligations. For instance, sections of the evaluated cash flows show that specific depreciation schedules can lead to increased capital available for use within a firm, affecting cash management strategies significantly (Marchioni & Magni, 2018).

Continuing with the implications on cash flow and NPV, the values indicate a situation where a project’s feasibility rapidly shifts due to altered cash inflows and costs. The assessment of cash positions specified lower net cash flows would result in diminishing project value over time. This situation becomes critical when assessing potential investment projects facing constrained capital availability (Persson, 2019).

NPV evaluations showed project B and project C as favorable under varied cost of capital considerations. This was substantiated by a higher internal rate of return (IRR) connected to NPV metrics, illustrating a compelling argument for investment depending on available resources and projected investment horizons (Azizurrofi et al., 2017).

The profitability index was highlighted as an effective evaluation tool to determine which project to undertake. A profitability index greater than one indicates potential value addition to the enterprise. Projects B and C had subsequent indices validating them as worthwhile investments when compared against project A. Thus, NPV and profitability index metrics offer broad insights into successful project selection processes for businesses (Ohrn, 2019).

Moreover, understanding the implications of the tax environment on earnings and cash management highlights an often-overlooked aspect of investment strategies. More favorable tax treatment of operating expenses can lead to enhanced capital flow. It hinges on the strategic overall management of tax duties and cash implications, which further emphasize the necessity of conducting thorough tax evaluations while exploring potential investments.

To conclude, tax evaluations concerning investments play a pivotal role in determining a project's viability. The integration of careful NPV analysis, understanding of depreciation’s impact, and employing performance metrics such as IRR and profitability indexes become key facets. Enhanced insights into these relationships empower businesses to strategically manage investments while optimizing financial performance over time.

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.

  • Azizurrofi, A., Firdaus, R. R., Akbar, W. J., Adisatria, A. R. I. N. G. G. A., Asnidar, A. S. N. I. D. A. R., Iskandar, A. R. I., & Misfaroh, Z. (2017). Economic Analysis of Profitability Index and Development Cost Based on Improved Oil Recovery (IOR) Projects in Indonesia.

  • Marchioni, A., & Magni, C. A. (2018). Investment decisions and sensitivity analysis: NPV-consistency of rates of return. European Journal of Operational Research, 268(1), 280-291.