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Gunning industries is considering a new investment in a machine which has a five-year life. The investment in the new machine would also require an immediate increase in working capital of $35,000. Gunning is subject to a 40% corporate tax rate and has a 10% average weighted cost of capital.
What is the overall discounted cash flow effect on Gunning industries ‘working capital investment over the life of the new machine?
A. ($7,959)
B. ($10,680)
C. ($13,265)
D. ($35,000)I have worked this question and obtained the answer C. What I’m not sure of is why we do not tax the working capital.
Working capital does not give rise to a tax effect.
It is financing additional receivables, additional inventory etc., and they do not affect tax.
I suggest that you watch my free lectures, because I explain this in my lectures.
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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