Chapter 8, Problem 1TPC

Firm Z, a corporation with a 21 percent tax rate, has $100,000 to invest in year 0 and two investment choices. Investment 1 will generate $12,000 taxable cash flow annually for years 1 through 5. In year 5, the firm can sell the investment for $100,000. Investment 2 will not generate any taxable income or cash flow in years 1 through 5, but in year 5, the firm can sell Investment 2 for $165,000.

1. a. Assuming a 6 percent discount rate, which investment has the greater NPV?
2. b. Would your answer change if Firm Z were a noncorporate taxpayer with a 35 percent tax rate and the gain on sale of Investment 2 were eligible for the 15 percent capital gains rate?