You can take a $1 million project. However, this kind of project is ordinary income for you, and it will produce either nothing or $3 million next year, both with equal probabilities. Assume that your taxable opportunity cost of capital is 10% and your combined tax rate is 35%. Your after-tax cost of capital is thus 6.5%.
(a) What is the project worth? Assume that you could fully use tax losses to offset other income taxed at 35%, too.
(b) How would your answer change if you could not use the tax losses elsewhere?