Question

Vern plans to invest $100,000 in a growth stock, in year 0. The stock is not expected to pay dividends. However, Vern predicts that it will be worth $135,000 when he sells it in year 3. The $35,000 increase in value will be taxable at the preferential capital gains rate of 15 percent.
Required:
a. Using a 4 percent discount rate, calculate the net present value of after-tax cash flows from this investment. (Round discount factor(s) to 3 decimal places. Round your intermediate calculations and final answer to the nearest whole dollar amount.)
b. Which two of the four basic tax planning variables increase the value of Vern's investment?

Answer 1

Answer:

a) $15,347

b) Time period

• Character

Explanation:

Initial investment = $100,000

Tax payable = ( 135,000 - 100,000 ) * 15%

                     = 35,000 * 0.15 = $5250

Amount receivable after tax = $135,000 - $5250 = $129,570

n  = 3 years

a) Using a 4% discount rate calculate NPV

NPV = 129570 / ( 1 + 0.04 )^3 - Initial investment

        = 129570 / ( 1.04 )^3 - 100,000

        ≈  $15,347

b) The two basic tax planning variables that increases the value of Vern's investment

• Time period
• Character