Question 2: (a) You are part of a group of consultants for a corporation (Applegate, INC) that wants to invest $10,000 in a new project this year (which we count as Year 0) in country X. This is the data given for the project: 1. In constant prices, the project will sell $6,000 worth of goods for EACH of the next 4 years, after which the project will end and have no salvage value. 2. The cost of goods sold is $2,000 per year (except that one quarter of the goods sold in any year are in fact made the previous year; and production starts in Year 0). 3. The tax collectors charge a tax of 40% 4. Straight line depreciation is allowed as well as FIFO accounting, 5. The investment package consists of equal portions of debt (at 8% real) and equity. 6. Nonetheless, there is a disagreement about INFLATION. You project 0% inflation in the foreseeable future, but some of your colleagues think that inflation will be 10%, while others think it will be only 5%. Discount rate is 10%. Calculate what effect these different assumptions about inflation have about the profitability of the project and the present value of the revenue collected by the government measured in year zero prices (if the project goes ahead). (b) Tanzi Effect: Country Y collects 24% of its GNP in taxes. Taxes are paid with an average lag of 2 months. The country joins the EU, and its inflation drops from 12% to 4%. Calculate what effect this will have on the proportion of GNP collected in the form of taxes. 7. Question 2: (a) You are part of a group of consultants for a corporation (Applegate, INC) that wants to invest $10,000 in a new project this year (which we count as Year 0) in country X. This is the data given for the project: 1. In constant prices, the project will sell $6,000 worth of goods for EACH of the next 4 years, after which the project will end and have no salvage value. 2. The cost of goods sold is $2,000 per year (except that one quarter of the goods sold in any year are in fact made the previous year; and production starts in Year 0). 3. The tax collectors charge a tax of 40% 4. Straight line depreciation is allowed as well as FIFO accounting, 5. The investment package consists of equal portions of debt (at 8% real) and equity. 6. Nonetheless, there is a disagreement about INFLATION. You project 0% inflation in the foreseeable future, but some of your colleagues think that inflation will be 10%, while others think it will be only 5%. Discount rate is 10%. Calculate what effect these different assumptions about inflation have about the profitability of the project and the present value of the revenue collected by the government measured in year zero prices (if the project goes ahead). (b) Tanzi Effect: Country Y collects 24% of its GNP in taxes. Taxes are paid with an average lag of 2 months. The country joins the EU, and its inflation drops from 12% to 4%. Calculate what effect this will have on the proportion of GNP collected in the form of taxes. 7