Question

Assume again that the cost of capital is 7 percent and the effective tax rate is 40 percent. How would the payback, internal rate of return, and net present value change if the capital cost for the project was $750,000 and the cost savings and increased revenue were decreased by 25 percent each year?

Answer 1

Answer:

If the effective tax rate increases then the net savings coming from investments will get lowered as a result the investment will have higher payback period (The increase in effective tax rate would lower demand of the product which means there is decline in net saving arising from the sale of the product). Likewise this decrease in annual net savings will also decrease the internal rate of return which shows that their are increased chances of project rejections. The NPV method is based on cash flows and relevant costing just like IRR and payback method but the only difference is that it assumes that the cash earned would be reinvested at cost of capital. The NPV will also decrease due to increased effective tax rate.