21 May COMPARE THE NET PRESENT VALUES FOR THE ORIGINAL TRANSACTION AND THE ALTERNATIVE.
Firm H has the opportunity to engage in a transaction that will generate $100,000 of cash flow (and taxable income) in year 0. How does the net present value of the transaction change if the firm could restructure the transaction in a way that does not affect the before-tax cash flow but results in no taxable income in year 0, $50,000 of taxable income in year 1, and the remaining $50,000 of taxable income in year 2. Assume a 10 percent discount rate and a 34 percent marginal tax rate for the three-year period.
Do the problem as follows:
1) Calculate the net present value for the original transaction.
2) Calculate the net present value for the alternative transaction by figuring the tax cost at the end of year 1 and the end of the year 2 assuming taxable income of $50,000 at the end of each of those years.
3) Discount the tax cost for each of those two years to the present.
4) Subtract the net present value of the tax costs from the $100,000 of taxable income.
5) Compare the net present values for the original transaction and the alternative.
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