You can take a $1 million project. However, this kind of project is ordinary inc

Question

You can take a $1 million project. However, this kind of project is ordinary income for you, and it will produce either nothing or $3 million next year, both with equal probabilities. Assume that your taxable opportunity cost of capital is 10% and your Combined tax rate is 35%. Your after-tax cost of capital is thus 6.5%. What is the project worth? Assume that you could fully use tax losses to offset other income taxed at 35%, too. How would your answer change if you could not use the tax losses elsewhere?

Explanation / Answer

1 When there is an opportunity to offset tax losses of this project against income from others, the cash flows of this project can be discounted @ B tax COC of 10% Cash flows PV F @ 10%Before Tax COC PV Year 0 -1000000 1 -1000000 Year 1 1500000 0.90909 1363636 Net Worth of the project 363636 Year 1 cash flow= (50%*0)+(50%*3000000)= 1500000 2 When there is no opportunity to offset tax losses of this project against income from others, the cash flows of this project should be discounted @ A tax COC of 6.5% Cash flows PV F @ 6.5%After Tax COC PV Year 0 -1000000 1 -1000000 Year 1 1500000 0.93897 1408451 Net Worth of the project 408451

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.