BPP Question on investment appraisal:

The flows (ignoring the revenue) are as follows: 0 Cost (150,000) 0 Tax saving on depreciation (150,000 x 0.3) 45,000 So a PV of (105,000) If the revenue is R, then the after tax flow in 2 years time is R - 0.3R = 0.7R For break even, then NPV needs to be zero, and therefore the PV of 0.7R has to equal 105.000 So 0.7R x 0.826 = 105,000 R = 181,598, and so the answer has to be D (The reason that it is a bit different to 181,500 is due to rounding - the exact discount factor of 2 years at 10% - 1/(1.1)^2 and if you do it to more decimal places then it does come to 181,500)

But there are two tax effects - the tax saving on the tax allowable depreciation but also the tax that have to be paid on the revenue. If the revenue is R, then they will have to pay tax of 0.3R on it, leaving a net inflow of 0.7R

You are welcome :-)

Hi John... i have a quick question. The question above says "what is the minimum value of the pre tax contract revenue " required. I believe pre tax means before tax effect..So shouldnt R be not after deducting tax? Please help me on this?

Pre-tax does indeed mean before tax. But the tax is affected by the revenue and in what I wrote above R is pre-tax.

Thank you

You are welcome :-)