A project requires an initial investment of $100,000 and is expected to produce a cash inflow before tax of $26,000 per year for five years. Company A has substantial accumulated tax losses and is unlikely to pay taxes in the foreseeable future. Company B pays corporate taxes at a rate of 35% and can depreciate the investment for tax purposes using the five-year MACRS tax depreciation schedule. Suppose the opportunity cost of capital is 8%. Ignore inflation.
a. Calculate project NPV for each company.
b. What is the IRR of the after-tax cash flows for each company? What does comparison of the IRRs suggest is the effective corporate tax rate?