Your friend is trying to decide between making one of two possible investments, each with its own series of cash inflows and cash outflows occurring over the next five years. Currently, your friend is thinking of simply choosing the option that results in the largest sum of all net cash flows before considering the impact of taxation or the time value of money.

a) In your own words, explain why your friend should use an after-tax rather than a before-tax perspective when determining the best investment choice. In your response, explain how to correctly calculate the after-tax value of receiving $1,000 of income as a cash inflow in Year 0, and the after-tax cost of a paying a $500 deductible expense as a cash outflow in Year 0 for two different taxpayers: Person A has a marginal tax rate of 22%, and Person B has a marginal tax rate of 35%.

b) In your own words, explain why your friend should incorporate the time value of money into the investment analysis. Why is it important to specify a discount rate and calculate the net present value (NPV) of each investment that generates net cash flows over multiple years? Assuming a discount rate of 10%, interpret the meaning of a NPV that is positive (greater than zero), a NPV that is negative (less than zero), and a NPV that is equal to zero. Explain when you would possibly choose to make an investment with a NPV that is negative.

Use the following information and Appendix A from your class text to complete the remaining parts: Cookie must decide between investing in one of two business opportunities. Assume Cookie uses a 12% discount rate and has a 40% marginal tax rate each year. The related net cash flows are provided below. Negative net cash flows appear within parentheses and represent fully deductible losses recognized in that tax year. Positive net cash flows appear without parentheses and represent taxable income recognized in that tax year.

Option 1 will generate the following net cash flows before tax: $10,000 in 2020 (year 0), $15,000 in 2021 (year 1), and $20,000 in 2022 (year 2).

Option 2 will generate the following net cash flows before tax: $14,000 in 2020 (year 0), ($15,000) in 2021 (year 1), and $48,000 in 2022 (year 2).

Option 3 will generate the following net cash flows before tax: ($8,000) in 2020 (year 0), $17,000 in 2021 (year 1), and $37,000 in 2022 (year 2).

c) Clearly show your calculation of the NPV for Option 1, Option 2, and Option 3. All else equal, identify which option Cookie should select.

d) Now assume that Cookies marginal tax rate over the three years is only 15% (rather than 40%) and the discount rate is 5% (rather than 12%). Clearly show your revised calculations of the NPV for Option 1, Option 2, and Option 3. All else equal, identify which option Cookie should select.

Hint: Use timelines to organize your answers. You can actually create Excel spreadsheets to present your solutions for parts (c) and (d) above, and then copy and paste your spreadsheets into this Word document just be certain to clearly show each of your calculations to receive full credit.