Frida is an entrepreneur. She is interested in setting up a corporation using her own funds of 240,000. She is offered the following project:

t 0 1 2 3 CFt (in ) -240,000 90,000 150,000 85,000

Straight-line depreciation applies. Frida uses her equity to set up a new corporation. Corporations are subject to a tax of 28%. Dividends are taxed at a rate of 22%. The interest rate after tax (or the after-tax cost of capital) amounts to 4%. Please assume that after-tax cash flows are to be taken out as dividends or as capital decreases (that is, via share buybacks) at the end of each period.

a) What is the net present value after taxes (NPV )? Comment your result.

b) How does the NPV in b) change if the investment is financed with retained earnings? (Note: you do not have to calculate the NPV to answer this question.)

c) How would the result change if the investment is financed with debt, assuming that you have to pay an interest rate of 4.5% to the bank. (Note: you do not have to calculate the NPV to answer this question.)

d) Continuing from b), please now assume that you have the opportunity to reinvest the cash flows within the firm. Please assume that the corporation can realize a pre-tax return on reinvestments in financial assets of 5.5%. Given these assumptions, is it optimal for Frida to pay out dividends and hence to decrease capital in year t=1 and t=2? (Note: you do not have to calculate the NPV to answer this question.)

e) Continuing from d), what is the minimum required pre-tax rate of return in reinvestments so that you are indifferent between paying out dividends and reinvesting within the firm?