AE9-12 Cash Flow Implications of Tax Losses [LO 4] WesternGear.com is expected t

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AE9-12

Cash 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 = $ _________________






Depreciation Tax Shield [LO 4]

Strauss Corporation is making a $70,000 investment in equipment with a 5-year life. The company uses the straight-line method of depreciation and has a tax rate of 40 percent. The company’s required rate of return is 11 percent.

What is the present value of the tax savings related to depreciation of the equipment? (Round the present value factor calculations to 4 decimal places, e.g. 0.2525. Round all other calculations and the final answer to 2 decimal places, e.g. 25.21.)

Present Value = $ _______________

Explanation / Answer

Third year income tax was completely offset with 1 & 2 years losses ie. 200000+250000 = 450000 (offset 250000*40% tax = 100,000) so here tax savings is 100,000 so present value of this tax savings is 100,000(100,000/(1.14)^3 = 67497.1516 )

Third year income tax was completely offset with 1 & 2 years losses ie. 200000+250000 = 450000 (offset 375000*40% tax = 150,000) so here tax savings is 150,000 so present value of this tax savings is 150,000(150,000/(1.14)^4 = 88812.0416 )

You should not ask more than one question in single post but I answer first question thank you…

Operating Loss of First year 1 -200000 Operating Loss of Second year 2 -250000 Income before taxes in its third year 3 250000 Income before taxes in its fourth year 4 375000

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