CASH FLOW IMPLICATIONS OF TAX LOSSES WesternGear.com is expected to have operati

Question

CASH FLOW IMPLICATIONS OF TAX LOSSES


WesternGear.com is expected to have operating losses of $300,000 in its first year of business and $100,000 in its second year. However, the company expects to have income before taxes of $350,000 in its third year and $525,000 in its fourth year. The company’s require rate of return is 16%.

Assume a tax rate of 40 percent and 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 ALL VALUES TO 4 DECIMALS.


$ ___________________

Explanation / Answer

Present value of the tax saving for 1 st year: Tax = 40% operating loss = $300000 tax shied = $300000*40% = $120000 here r = 16% PV = [1/(1.16)^1] =0.8620 PV= $120000*0.8621 =$103425 Present value of the tax saving for 2nd year: Tax = 40% operating loss = $100000 tax shied = $100000*40% = $40000 here r = 16% PV = [1/(1.16)^2] =0.7432 PV= $40000*0.7432 =$29728 TOTA L TAX LOSSES SAVINGS WOULD BE = $103425+$29728 =$133153

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