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:

0 1 2 3

1. Intial investment 100

2. Revenue 100 100 100

3. Cash Operating Cost 50 50 50

4. Tax depreciation 33.33 33.33 33.33

5. Income Pretax 16.67 16.67 16.67

6Tax at 40% 6.67 6.67 6.67

7. Net Income 10 10 10

8. After Tax Saving 15

9. Cash flow (7+8+4 -1) -100 43.33 43.33 58.33

NPV at 20% = 0

Assumption: 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 given above yields NPV = 0.

b. If you decide to terminate the project in year two (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 one (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?

Please explain your answer in detail and provide in-text citations