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• #232504
Charanpreet Kaur
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Hi There,

I got confused regarding what cash-flow I should take while calculating NPV. Like in some questions we take cash-flow(before tax)like in below example 1 and in some cases we are taking after-tax. So how do I know if I have to take before tax/after tax cashflow. Thanks

Example1:12. Question ID: CMA 1295 4.12 (adapted) (Topic: Net Present Value Method)

Willis Inc. has a cost of capital of 15% and is considering the acquisition of a new machine which costs \$400,000 and has a useful life of 5 years. Willis projects that earnings and cash flow will increase as follows:

 Net Year After-Tax Earnings Cash Flow 1 \$100,000 \$160,000 2 100,000 140,000 3 100,000 100,000 4 100,000 100,000 5 200,000 100,000

Example2: its taking after tax cash flow in calculating NPV

Question ID: ICMA 10.P2.323 (Topic: Net Present Value Method)

Lunar Inc. is considering the purchase of a machine for \$500,000 which will last 5 years. A financial analysis is being developed using the following information.

 Year 1 Year 2 Year 3 Year 4 Year 5 Unit sales 10,000 10,000 20,000 20,000 20,000 Selling price per unit \$     100 \$     100 \$      100 \$     100 \$     100 Variable cost per unit 65 65 65 65 65 Fixed costs 300,000 300,000 300,000 300,000 300,000 Pre-tax cash flow 50,000 50,000 400,000 400,000 400,000

The machine will be depreciated over 5 years on a straight-line basis for tax purposes and Lunar is subject to a 40% effective income tax rate. Assuming Lunar will have significant taxable income from other lines of business, and using a 20% discount rate, the net present value of the project would be

• This topic was modified 1 week, 6 days ago by Lynn Roden. Reason: Corrected HTML in Visual view
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• #232508
Lynn Roden
HOCK international

Hello Charanpreet Kaur,

Those are two different questions and they give different information. Every question stands on its own, and for each question you answer, you should use only the information given in that question. If you use information given in some other question, then you are answering that other question and not the question you are trying to answer.

CMA 1295 4.12 does not give a tax rate, nor does it specify whether the cash flows given are before tax or after tax. Therefore, the only cash flow amounts available to use are the cash flow amounts given. So that is what you use to calculate the NPV.

ICMA 10.P2.323 states that the cash flow amounts given are pre-tax and it gives the effective tax rate. Therefore, the cash flow amounts given are to be reduced by the income tax due on them before using them to calculate the NPV.

Lynn

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