A company is planning to invest $75,000 (before taxes) in a personnel training p

Question

A company is planning to invest $75,000 (before taxes) in a personnel training program. The $75000 outlay will be charged off as an expense by the firm this year (Year 0). The returns estimated from the program in the forms of greater productivity and less employee turnover are as follows (on an after-tax basis):

Years 1-10: $7,500 per year

Years 11-20: $22,500 per year

The company has estimated its cost of capital to be 15%. Assume that the entire $75,000 is paid at time zero (the beginning of the project). The marginal tax rate for the firm is 40%. Based on the net present value criterion, should the firm undertake the training program?

Explanation / Answer

We should calculate the Net Present Value of the future cash flows to decide whthr to take the project or not. to take up the project the NPV must be greater than zero given cost of capital=15% the tax deducted on the cash flow = 40% The intial 75000$ cot is before tax hence the tax must be deducted before comparision The residual cash flow once we remove the tax = 60% NPV calculation NPV = -$75,000 + $7,500(0.6)/1.15 +$7,500(0.6)/1.15^2+$7,500(0.6)/1.15^3+$7,500(0.6)/1.15^4+$7,500(0.6)/1.15^5+$7,500(0.6)/1.15^6+$7,500(0.6)/1.15^7+$7,500(0.6)/1.15^8+$7,500(0.6)/1.15^9+$7,500(0.6)/1.15^10 + $22,500(0.6)/1.15^11+$22,500(0.6)/1.15^12+$22,500(0.6)/1.15^13+$22,500(0.6)/1.15^14+$22,500(0.6)/1.15^15+$22,500(0.6)/1.15^16+$22,500(0.6)/1.15^17+$22,500(0.6)/1.15^18+$22,500(0.6)/1.15^19+$22,500(0.6)/1.15^20 =($9,446.57*0.6)=5667.942

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