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Hi Sir,
Please could you clarify how we arrive to the answer of $917,000?
A project is expected to generate pre-tax income of $90,000 per annum, starting in one year
and running in perpetuity. Tax is payable 12 months in arrears at 20%. The after tax cost of
capital is 8%.What is the PV of the project flows?
The PV of $90,000 p.a. in perpetuity is 90,000 / 0.08 = $1,125,000.
The tax is 20% x 90,000 p.a. but is 1 year later than the income.
Therefore the PV of the tax will be 20% x the PV of the income, but will need discounting for 1 year because the flows are all 1 year later.20% x 1,125,000 x 1/1.08 = $208,333
Therefore the overall PV = 1,125,000 – 208,333 = $916,667 (or $917,000 to the nearest thousand).
There are other ways of calculating the PV of the tax flows giving obviously the same final answer, but this is the most efficient way 🙂
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