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 34 percent marginal tax rate for the three-year period.

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Business

Dominik Richmond

7 May, 03:35

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 34 percent marginal tax rate for the three-year period.

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Gabriella · Answer 1

The NPV will increase by $5,187 following the restructure of the transaction.

Explanation:

We have the cash outflow due to tax payment as followed:

* Before transaction restructured:

Tax payment of 100,000 * (1 - 34%) = $66,000 at the end of Year 0;

=> Present value of this cash outflow is: (66,000) / 1.06 = $ (62,264)

* After transaction restructured:

Tax payment at the end of year 1: 50,000 * (1 - 34%) = $33,000;

Tax payment at the end of year 2: 50,000 * (1 - 34%) = $33,000.

=> Present value of this cash outflows are: (33,000) / 1.06^2 + (33,000) / 1.06^3 = $ (57,077).

=> Increase in NPV after transaction structured will be equal to the saving in present value of cash out flow = (57,077) - (62,264) = $5,187.

So, the answer is NPV will increase by $5,187.