Ace Company has a 25 percent marginal tax rate and uses a 10% discount rate to c

Question

Ace Company has a 25 percent marginal tax rate and uses a 10% discount rate to compute NPV. The firm started a venture that will yield the following before-tax cash flows: year 0, $28,000; year 1, $60,000; year 2, $90,000; year 3, $85,000.

a.       If the before tax cash flows represent taxable income in the year received, compute the NPV of the cash flows to Ace..

b.      Compute the NPV if Ace can defer the receipt of years 0, 1 and 2 cash flows/ until year 3. ( It would receive no cash in years 0,1, and 2 and would receive all the cash flows in year 3)

c.       Compute the NPV if ACE can defer paying tax on years 0 and 1 cash flows until year 2. ( It would receive $90,000 cash in year 2 but would pay tax on $178,000 of income). It would also still receive $85,000 of cash in year 3.

Explanation / Answer

(a) if before tax cash flow represent taxable income

year cash flow after tax p.v factor NPV

0 $21000 1 21000

1 $45000 .909 40905

2 $67500 .826 55755

3 $63750 .751 47876

NPV 165536

(b)

cash flow after tab on 3rd year= $263000*75%=197250

p.v factor = .751

NPV 197250*.751=148135

(C)

cash flow after tax on year 2=$178000*75%=133500*.826=110271

cash flow after tax on year 3=$85000*75%=63750*.751 = 47876

NPv 158147

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