Course Learning Assessment $1$

Taxes are costs, and, therefore, changes in tax rates can affect consumer prices, project

lives, and the value of existing firms. Evaluate the change in taxation on the valuation of

the following project:

Assumptions: Tax depreciation is straight$-$line over three years. Pre$-$tax salvage value is $25$

in Year $3$ and $50$ if the asset is scrapped in Year $2.$ Tax on salvage value is $40\%$ of the

difference between salvage value and book value of the investment. The cost of capital

is $20\%.$

a$.$ Please verify that the information above yields NPV $=0.$

b$.$ If you decide to terminate the project in Year $2,$ what would be the NPV of the

project?

c$.$ Suppose that the government now changes tax depreciation to allow a $100\%$ write$-$

off in Year $1.$ How does this affect your answers to parts a and $b$ above?

d$.$ Would it now make sense to terminate the project after two rather than three

years?

e$.$ How would your answers change if the corporate income tax were abolished

entirely?