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?

A personnel training program can create future growth for the company.

Explanation / Answer

Here we have at T0, Investment Y0 = -75,000 (Bef Tax) Cost of capital is Rate = 15% Returns for Y0 to Y10 is pmt = $7500 per year for nper = 10 yrs PV of Yo to Y10 = PV(Rate, nper, pmt) = PV(15%,10,-7500) = $37,641 Returns for Y11 to Y20 is pmt = $22,500 per year for nper = 10 yrs PV of Y11 to Y20 at end of Y10 = PV(Rate, nper, pmt) = PV(15%,10,-22,500) = $112,922 As this is PV at end of Y10, PV at Y0 = FV/(1+Ks)^10 = 112,922/(1+15%)^10 = $27,913 So PV of Returns after Tax = $37,641+$27,913 = $65,554 Tax Rate is 40% SO PV of Return Before Tax = Return after Tax/(1-40%) = $65,554/0.6 = $109,256 So NPV = Initial Investment Bef Tax + PV of Return Bef Tax ie NPV = -75,000 + 109,256 = $34,256 As NPV is Positive, firm should undertake this Trg program

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