Question

5. Firm Q is about to engage in a transaction with the following cash flows over a three-year period: Year 0 Year 1 Year 2 Revenue Received $10,000 $12,500 $18,000 Deductible expenses (3,400 (5,000 (7,000 Nondeductible expenses (800 (1,100 -0- If the firm’s marginal tax rate over the three-year period is 35% and its discount rate is 10%, compute the net present value of the transaction.

Answer 1

Answer: $12,830.91‬

Explanation:

Year 0

Net Cash = Revenue - Expenses - Tax

Tax = (Revenue - Deductible expenses) * tax rate

= ( 10,000 - 3,400) * 0.35

= $2,310‬

Net Cash = 10,000 - 3,400 - 800 - 2,310

= $3,490‬

Present Value is the same as this is Year 0.

Year 1

Tax = (Revenue - Deductible expenses) * tax rate

= ( 12,500 - 5,000) * 0.35

= $2,625

Net Cash = 12,500 - 5,000 - 1,100 - 2,625

= $3,775‬

Present Value is;

= 3,775 / ( 1 + 10%)

= $3,431.82

Year 2

Tax = (Revenue - Deductible expenses) * tax rate

= ( 18,000 - 7,000) * 0.35

= $3,850‬

Net Cash = 18,000 - 7,000 - 0 - 3,850‬

= $7,150

Present Value is;

= 7,150 / ( 1 + 10%) ^ 2

= $5,909.09

Net Present Value = PV0 + PV1 + PV2

= 3,490‬ + 3,431.82 + 5,909.09

= $12,830.91‬