37. Effective tax rates (S6.2) 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 – TC)/I, where TC is the statutory tax rate. The effective rate, call it TE, is T E =

C / I − C (1 − T C ) / I ____________ C / I = T C In this case, the effective rate equals the statutory rate.

a. Calculate TE the effective tax rate for the guano project in Section 6-3.

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