## Taxes are Costs, and, Therefore, Changes in Tax Rates

Taxes are Costs, and, Therefore, Changes in Tax Rates for \$1 Only (Instant Download)

Taxes are costs, and, therefore, changes in tax rates can affect consumer prices, project lives, and the value of existing firms. Evaluate the change in taxation on the valuation of the following project:

Assumptions: Tax depreciation is straight-line over three years. Pre-tax salvage value is 25 in year 3 and 50 if the asset is scrapped in year 2. Tax on salvage value is 40% of the difference between salvage value and book value of the investment. The cost of capital is 20%.

1. Please verify that the information given above yields NPV = 0.
2. If you decide to terminate the project in year two (2) what would be the NPV of the project?
3. Suppose that the government now changes tax depreciation to allow a 100% write-off in year one (1). How does this affect your answers to parts a and b above?
4. Would it now make sense to terminate the project after two rather than three years?

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## Finance Question II

Finance Question II

The real estate agent tells the Bergholts that if they don’t care to purchase, they might consider renting. The rental option would cost \$1,400/month plus utilities estimated at \$220 and renter’s insurance of \$25/month. The Bergholts believe that neither of them is likely to be transferred to another location within the next five years. After that, Dan perceives that he might move out of government service into the private sector. Assuming they remain in the same place for the next five years, the Bergholts would like to know if it is better to buy or rent the home. They expect that the price of housing and rents will rise at an annual rate of 3% over the next five years. They expect to earn an annual rate of 5% on the money market fund. All other prices, including utilities, maintenance, and taxes are expected to increase at a 3% annual rate. After federal, state, and local taxes, they get to keep only 55% of a marginal dollar of earnings.

1. Estimate whether it is financially more attractive for the Bergholts to rent or to purchase the home over a five-year holding period. (Assuming the contract interest rate of 8%, monthly interest payments over the five-year period would total \$87,574.)
2. Suppose it turns out that they have to relocate after one year. Which is the preferred alternative after one year? (Interest payments over the first year would equal \$17,852.)

Show all work for each assignment and explain each step carefully.