A project requires an initial investment of $10,000, straight-line depreciable to zero over four years. The discount rate is 10%. Your tax bracket is 34% and you receive a tax credit for negative earnings
In the year in which the loss occurs. Additional information for variables with forecast error are
Shown below. What is the best case NPV for the project?
A) $5,247
B) $26,462
C) $29,306
D) $32,327
E) $34,252

Question

A project requires an initial investment of $10,000, straight-line depreciable to zero over four years. The discount rate is 10%. Your tax bracket is 34% and you receive a tax credit for negative earnings
In the year in which the loss occurs. Additional information for variables with forecast error are
Shown below.  What is the best case NPV for the project?
A) $5,247 
B) $26,462 
C) $29,306 
D) $32,327 
E) $34,252

Quizplus · Accepted Answer

1) Calculate annual depreciation: $10,000/4=$2,500
2) Calculate annual operating income: $5,000
3) Calculate annual taxable income: $5,000-$2,500=$2,500
4) Calculate annual taxes: $2,500*34%=$850
5) Calculate annual after-tax income: $2,500-$850=$1,650
6) Calculate after-tax cash flow (including depreciation): $1,650+$2,500=$4,150
7) Calculate PV of cash flows: 
Year 1: $4,150/(1+10%)^1=$3,773
Year 2: $4,150/(1+10%)^2=$3,430
Year 3: $4,150/(1+10%)^3=$3,119
Year 4: $4,150/(1+10%)^4=$2,838
Total PV of cash flows= $13,160
8) Calculate PV of initial investment: $10,000
9) Calculate NPV: $13,160-$10,000=$3,160
The best case NPV is the highest possible NPV, which occurs when all the forecast errors are in the project's favor (i.e. no negative earnings or cost overruns). Since the only option with a NPV above $3,160 is C) $29,306, that is the best choice.

A Project Requires an Initial Investment of $10,000, Straight-Line Depreciable