Taxpayer is considering the following investment. Year 1 Year 2 Year 3 Year 4 Ye
ID: 2340215 • Letter: T
Question
Taxpayer is considering the following investment.
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Cash income produced
4,000
11,000
20,000
23,000
25,000
30,000
Cash expenses
1,000
5,000
6,000
8,000
8,000
10,000
Expenses that are tax deductible
None
80%
70%
80%
100%
75%
Marginal tax rate
20%
24%
24%
30%
30%
30%
Compute the present value of the after-tax cash flows of this investment, using a discount rate of 6%. Note: This investment begins with year 1, not year 0. Your cash flows should be discounted accordingly.
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Cash income produced
4,000
11,000
20,000
23,000
25,000
30,000
Cash expenses
1,000
5,000
6,000
8,000
8,000
10,000
Expenses that are tax deductible
None
80%
70%
80%
100%
75%
Marginal tax rate
20%
24%
24%
30%
30%
30%
Explanation / Answer
As the investment begins in Year 1, not Year 0, this is an Annuity due where payments occur at the beginning of each period.
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Income
$4,000
$11,000
$20,000
$23,000
$25,000
$30,000
Present value of the after-tax cash flows of this investment = $3,200 + $5,016.76 + $10,687.12 + $9,760.8 + $9,424.8 + $11,765.25
= $49,854.73
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Income
$4,000
$11,000
$20,000
$23,000
$25,000
$30,000
Expenses 0 $4,000 ($5,000*80%) $4,200 ($6,000*70%) $6,400 ($8,000*80%) $8,000 ($8,000*100%) $7,500 ($10,000*75%) Profit $4,000 $7,000 $15,800 $16,600 $17,000 $22,500 Marginal tax rate 20% 24% 24% 30% 30% 30% Tax on profits $800 ($4,000*20%) $1,680 ($7,000*24%) $3,792 ($15,800*24%) $4,980 ($16,600*30%) $5,100 ($17,000*30%) $6,750 ($22,500*30%) After tax cash flow $3,200 $5,320 $12,008 $11,620 $11,900 $15,750 PVAF 1 0.943 0.890 0.840 0.792 0.747 Present value of after tax cash flows $3,200 ($3,200*1) $5,016.76 ($5,320*0.943) $10,687.12 ($12,008*0.890) $9,760.8 ($11,620*0.840) $9,424.8 ($11,900*0.792) $11,765.25 ($15,750*0.747)Related Questions
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