Homework : Part B


Homework : Part B

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pls999
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On The part (B), I am not sure if the tax=0 or tax=35% x (-10,200,000) becasue the pretax profit is negative (-10,200,000). Does anyone know about it ? In other words, does the company get tax back if the profit is negative ? Thanks.

[NEAS: The firm pays taxes on corporate income.  If one project makes $100,000 pre-tax, the firm pays $35,000 on taxes on that project.  If a second project losses $100,000 pre-tax, the firm pays nothing in total.  It implicitly pays $35,000 on the first project and gets a refund of $35,000 on the second project.

If the firm loses money in total, it can carry back an operating loss to recoup taxes paid in the past two years.  If it did not pay taxes in the past two years, it can carry forward its net operating losses up to five years to reduce future taxes.

We assume the firm can use operating losses on a project to offset income elsewhere, so it receives an implicit tax refund.  Advanced finance courses discuss the effects of carry backs, carry forwards, and the possibility of not being able to use tax credits.]


D
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You are right that the government do not give $ to company if they have losses.  If a company suffer from losses, they can get a "tax credit" (however you want to call it).

Look at Table 10.4 Under TAXES, you will see there is tax credit (-2.25).

[NEAS: The tax applies to the total firm.  Some projects make money and pay taxes.  Other projects lose money and get an implicit tax refund.

A tax credit can be carried back two years.  If the firm paid taxes in the past two years, it gets a refund of the tax paid.]


mcgowan04
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so (5) * 0.35  as the chart in the HW shows would be 0 in our case?

Therefore the NPV for part b = -40,000,000 - 5,200,000/(1.14^8)?


D
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mcqowan04: In the HW expected case.

NPV = -40+ 9.55/(1.14)+9.55/(1.14)^2+...9.55/(1.14)^8

(it's an annuity)

"so (5) * 0.35  as the chart in the HW shows would be 0 in our case?" 

No,  -1.75


D
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No, (5)*0.35 is not 0.

The pretax profit is -10.2MM, so tax credit is -3.57MM, Net profit is -6.63MM, Net CF is -1.63MM (for pessimistic case)


PedroT
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I got a Net Cash Flow of -1.630,000.  What does the depreciation credit has to do with the result?

[NEAS: If the firm writes off the $40 million as an expense in the first year, it gets a tax refund of $40 million x 35%.  If it writes off the $40 million over two years, it gets a tax refund of $20 million x 35% each year.  The present value of the total tax refund is lower.  The tax depreciation schedule says how quickly the firm can write off its initial investment on its tax return.  The present value of the tax refund changes by the deprecation schedule, even if the pre-tax cash flows do not change.


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Corpfin, Mod 9: Taxes

Jacob: If income is negative, is the tax liability zero or negative?

Rachel: When we evaluate a project, negative income offsets positive income. Suppose an insurer sells 1,000 personal auto insurance policies. Ten policies have losses of $5,000 apiece and the other 90 policies have gains of $1,000 apiece. The after-tax income is

10 × (–$5,000) × (1 – 35%) + 90 × (+$1,000) × (1 – 35%) = $26,000

Jacob: Does this apply to cohorts as well?

Rachel: Yes. An insurer expects to lose money the first year on a cohort of new business and to recoup the loss in renewal years. The first year loss on one cohort offsets gains on other cohorts.

Jacob: What if the insurer loses money in total? For example, what it Hurricane Katrina causes a net loss for the insurer?

Rachel: The loss may be carried back to the previous two years to offset taxable income in those years; the IRS gives a tax refund.

Jacob: What if the insurer lost money in the previous two years as well?

Rachel: The loss is carried forward and can offset income in future years. One shows a deferred tax asset in GAAP or statutory accounting statements.


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CorpFinance.Module9.tax.refunds.pdf (452 views, 18.00 KB)
al1835
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In the pessimistic case, for example: we get a net profit of -6,630,000. Then I subtract the depreciation and get -11,630,000. The problem says (7)+ (4), but it doesn't make sense to me that we add the depreciation. Doesn't depreciation mean "decrease in value", and so should be negative?

[NEAS: A depreciation tax credit reduces the tax liability, so it increases the after tax cash flows.]


cygne
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Why is "depreciation" calculated as 40000000/8 ?

Does this value apply to all 3 cases?
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