Question

Firm H has the opportunity to engage in a transaction that will generate $100,000 cash flow (and taxable income) in year 0. How does the NPV of the transaction change if the firm could restructure the transaction in a way that doesn’t change before-tax cash flow but results in no taxable income in year 0, $50,000 taxable income in year 1, and the remaining $50,000 taxable income in year 2? Assume a 6 percent discount rate and a 21 percent marginal tax rate for the three-year period. Use Appendix A and Appendix B.

Required:

1. Prepare a Original transaction.
2. Prepare a Restructured transaction.

Answer 1

A.

Original Transaction:

Year 0

Taxable Income $ 100,000

Tax at 21% $ 21,000

Before-Tax cash flow $ 100,000

Tax Cost ($ 21,000)

Net Cash Flow $ 79,000

NPV $ 79,000
B.

Restructured Transaction:

Year 0 Year 1 Year 2

Taxable Income $50,000 $50,000

Tax at 21% $10,500 $10,500

Before-Tax cash flow   $100,000 0 0

Tax Cost 0 ($10,500)   ($10,500)

Net Cash Flow $100,000 $39,500 $39,500

Discount factor(6%) 0.943 0.89

Present Value $100,000 $37,248.5 $35,155
NPV $ 72403.5