CHAPTER 6,,4. Mrs. T. Potts, the treasurer of Ideal China, has a problem. The company has just ordered a new kiln for $400,000. Of this sum, $50,000 is described by the supplier as an installation cost. Mrs. Potts does not know whether the Internal Revenue Service (IRS) will permit the company to treat this cost as a tax-deductible current expense or as a capital investment. In the latter case, the company could depreciate the $50,000 using the fiveyear MACRS tax depreciation schedule. How will the IRS’s decision affect the after-tax cost of the kiln? The tax rate is 35 percent and the opportunity cost of capital is 5 percent.,,,,,,,5. A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,000 per year for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company B pays corporate taxes at a rate of 35 percent and can depreciate the investment for tax,purposes using the five-year MACRS tax depreciation schedule. Suppose the opportunity cost of capital is 8 percent. Ignore inflation.,,a. Calculate project NPV for each company.,,,b. What is the IRR of the after-tax cash flows for each company? What does comparison of the IRRs suggest is the effective corporate tax rate?,,,16. You own 500 acres of timberland, with young timber worth $40,000 if logged now. This represents 1,000 cords of wood worth $40 per cord net of costs of cutting and hauling. A paper company has offered to purchase your tract for $140,000. Should you accept the offer? You have the following information:,,Yearly Growth Rate,Years of Cords per Acre,1–4 16%,5–8 11,9–13 4,14 and subsequent years 1,,,,,,• You expect price per cord to increase at 4 percent per year indefinitely.,• The cost of capital is 9 percent. Ignore taxes.,• The market value of your land would be $100 per acre if you cut and removed the,timber this year. The value of cut-over land is also expected to grow at 4 percent,per year indefinitely.,
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