AE9-12 Cash Flow Implications of Tax Losses [LO 4] WesternGear.com is expected t
ID: 2349938 • Letter: A
Question
AE9-12Cash Flow Implications of Tax Losses [LO 4]
WesternGear.com is expected to have operating losses of $200,000 in its first year of business and $250,000 in its second year. However, the company expects to have income before taxes of $250,000 in its third year and $375,000 in its fourth year. The company’s required rate of return is 14 percent.
Assume a tax rate of 40 percent and that current losses can be used to offset taxable income in future years. What is the present value of tax savings related to the operating losses in years 1 and 2?
(Round present value factor calculations to 4 decimal places, e.g. 0.2525. Round all other calculations and final answer to 0 decimal places, e.g. 5,252.)
Present Value $ _____________
AE9-16
IRR and Unequal Cash Flows [LO 3]
Newport Department Store is considering development of an e-commerce business. The company estimates that development will require an initial outlay of $1,330,000. Other cash flows will be as follows:
Year 1 ($583,700)
Year 2 $150,000
Year 3 $650,000
Year 4 $750,000
Year 5 $900,000
Assuming the company limits its analysis to five years, estimate the internal rate of return of the e-commerce business. (Round the present value factor calculations to 4 decimal places, e.g. 0.2525. Round the final answer to 0 decimal places, e.g. 25%.)
Internal rate of return = %
Should the company develop the e-commerce business if the required rate of return is 12 percent?
No or Yes
Explanation / Answer
Operating Loss of First year = $200,000
Operating Loss of Second year = $250,000
Income before taxes in its third year = $250,000
Income before taxes in its fourth year = $375,000
Company’s Required Rate of Return = 14%
Tax Rate = 40%
Present Value of Tax Savings related to the Operating losses in years 1 and 2?
Income before taxes of third year = $250,000
Tax Rate = 40%
Income after taxes of third year = [$250,000 - ($250,000 * 0.40)]
Income after taxes of third year = [$250,000 - $100,000]
Income after taxes of third year = $150,000
Present Value of Tax benefit (or) Tax Savings = $100,000 (PVF14%, 3)
Present Value of Tax benefit (or) Tax Savings = $100,000 * 0.6750
Present Value of Tax benefit (or) Tax Savings = $67,500
Income before taxes of fourth year = $375,000
Income after taxes of fourth year = [$375,000 – ($375,000 * 0.40)]
Income after taxes of fourth year = [$375,000 - $150,000]
Income after taxes of fourth year = $225,000
Present Value of Tax Savings = $150,000 * (PVF14%, 4)
Present Value of Tax Savings = $150,000 * 0.5921
Present Value of Tax Savings = $88,815
Initial Outlay = $1,330,000
Number of years = 5 years
Calculating Internal Rate of Return Using Ms-Excel Spread Sheet:
Year
Cash flows
0
($1,330,000)
1
($583,700)
2
$150,000
IRR = 7%
3
$650,000
4
$750,000
5
$900,000
Year
Cash flows
0
($1,330,000)
1
($583,700)
2
$150,000
IRR = 7%
3
$650,000
4
$750,000
5
$900,000
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.