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

$20\%.$

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

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

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?

Would it now make sense to terminate the project after two rather than three years?

How would your answers change if the corporate income tax were abolished entirely?

View the Activity Grading Rubric.