Question
Taxes are a cost, and, therefore, changes in tax rates can affect consumer prices, project lives, and the value of existing firms. The following
Taxes are a cost, and, therefore, changes in tax rates can affect consumer prices, project lives, and the value of existing firms. The following problem illustrates this. It also illustrates that tax changes that appear to be "good for business" do not always increase the value of existing firms. Indeed, unless new investment incentives increase consumer demand, they can work only by rendering existing equipment obsolete. The manufacture of bucolic acid is a competitive business. Demand is steadily expanding, and new plants are constantly being opened. Expected cash flows from an investment in a new plant are as follows: 0 1 2 3 1. Initial investment Revenues 114 2. 3. Cash operating costs 4. Tax depreciation 114.00 114.00 114.00 64.00 64.00 64.00 38.00 38.00 38.00 5. Income pretax 12.00 12.00 12.00 6. Tax at 34% 4.08 4.08 4.08 7. Net income 7.92 7.92 7.92 8. After-tax salvage 25.74 9. Cash flow (7 + 8 + 4 - 1) -114 45.92 45.92 71.66 NPV at 16% = 0 Assumptions: 1. Tax depreciation is straight-line over three years. 2. Pretax salvage value is 39 in year 3 and 64 if the asset is scrapped in year 2. 3. Tax on salvage value is 34% of the difference between salvage value and depreciated investment. 4. The cost of capital is 16%. a. What are the values of a one- and two-year-old plant? b. Existing plans must continue using the original tax depreciation schedule. What are the values of a one- and two-year-old plant? c. Calculate the net-of-tax salvage value of a two-year-old plant. d. Assume the corporate income tax was abolished entirely. What are the values of a one- and two-year-old plant? Complete this question by entering your answers in the tabs below. Required A Required B Required C Required D Assume the corporate income tax was abolished entirely. What are the values of a one- and two-year-old plant? (Do not round intermediate calculations. Round your answers to 2 decimal places.) One year Two year Value of the plant < Required C Required D >
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