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The important part of finding the present value of a project in the presence of taxes, is that depreciation reduces taxes. Taxes are levied on income (or cash received) minus depreciation. The present value of the project is computed using the net after-tax cash flow. It is about page 109 in the text where they discuss depreciation and taxes. Let’s suppose Revenue and Other Expenses are all cash. Taxes = (Revenue – Other Expenses – Depreciation Expense)*tax rate Cash Flow = Revenue – Other Expenses – Taxes The important part is that Cash Flow is not net income and taxes are not based on net income. The amount of taxes saved by computing taxes on (Revenue – Other Expenses – Depreciation Expense) rather than (Revenue – Other Expenses) is termed the depreciation tax shield.

Problem Statement

Able Enterprises has an investment proposed by a division manager. Here are the estimates

from the proposal:

1. The required investment for the project is $15,000.

2. The investment will result in five years of cash inflows of $10,000 each, assumed at the end

of each year.

3. The investment is in a depreciable asset that will last exactly the five years and have no

value after that date. This means that there is $3,000 of depreciation each year.

4. The tax rate is 30 percent. Taxes are computed on the income after depreciation. The

implication here is that taxes are levied on the cash minus the depreciation ($10,000 -$3,000).

5. The appropriate discount rate is 10 percent.

Required

1. What is the Net Present Value of the project?

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