The real (without inflation) required rate of return for a project is 10%. The corporate tax rate is 30%. Allowable depreciation in the third year of the project is C¼10,000. The tax effect of allowable depreciation on the cash flow of the project is favorable. It equals the allowable depreciation multiplied by the tax rate.

(a) What is the effect of allowable depreciation in the third year on the present value

(PV) of the project in the absence of inflation?

(b) What is the effect of allowable depreciation in the third year on the PV of the project if the expected rate of inflation is 5%?