Question

You are tasked with examining a project for Bore Industries. You know that without the project Bore will generate pre-tax income of $60 million each year in perpetuity. You have forecasted the following financial information of the project. Assuming a marginal tax rate of 25%, which of the following statements is true?

Project Forecasts in $-thousands

	Year
	0	1	2
EBIT	(5,000)	10,000	5,000

	I.	Taking this project will result in additional taxes of $1,250,000 for the firm at time 0. This will decrease the free cash flow of the project at time 0.
	II.	Taking this project will result in tax savings of $1,250,000 for the firm at time 0. This will have no effect on the free cash flow of the project at time 0.
	III.	Taking this project will result in additional taxes of $1,250,000 for the firm at time 0. This will have no effect on the free cash flow of the project at time 0.
	IV.	Taking this project will result in tax savings of $1,250,000 for the firm at time 0. This will increase the free cash flow of the project at time 0.

Note: Answer was not option #2. This is my last attempt so please provide the correct answer.

Answer 1

Following is the EBIT and its taxes in next 3 years. By Seeing to the question it ask only for year 1 impact on current cash flows. Compnay Currently earning 60M and In 25% tax Bracket. In project these is 5M loss in year 1. This loss can be sett off from the current Income of 60M. So If no project company has to pay tax @ 25% in year 1 on 60M and IF project will be there then company need to pay tax on 55 only due to loss sett off. So company benefitted Tax saving in year 1 of Rs 1.25M and it will increase Free cash flow to form.

EBIT	Taxes@25%
-5	-1.25
10	2.5
5	1.25

So the answer is option 4, i.e. 1.25M tax saving and increase in FCF.