One measure of the effective tax rate is the difference between the IRRs of pretax and after-tax cash flows, divided by the pretax IRR. Consider, for example, an investment I generating a perpetual stream of pretax cash flows C. The pretax IRR is C / I, and the after-tax IRR is C (1  T C )/ I, where T C is the statutory tax rate. The effective rate, call it T E , is TE 5 C/I 2 C11 2 Tc 2 /I C/I 5 Tc Visit us at www.mhhe.com/bma Visit us at www.mhhe.com/bma Visit us at www.mhhe.com/bma Chapter 6 Making Investment Decisions with the Net Present Value Rule 153 In this case the effective rate equals the statutory rate.

a. Calculate T E for the guano project in Section 6.2.

b. How does the effective rate depend on the tax depreciation schedule? On the inflation rate?

c. Consider a project where all of the up-front investment is treated as an expense for tax purposes. For example, R&D and marketing outlays are always expensed in the United States. They create no tax depreciation. What is the effective tax rate for such a project?

AppendixLO1