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.]

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.

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)

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

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)?

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.]

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.]