Principles of Corporate Finance_ 12th Edition

bre44380_ch06_132-161.indd 143 09/30/15 12:46 PM

Chapter 6 Making Investment Decisions with the Net Present Value Rule 143

Table 6.5 recalculates the guano project’s impact on IM&C’s future tax bills, and Table 6.6
shows revised after-tax cash flows and present value. This time we have incorporated realistic
assumptions about taxes as well as inflation. We arrive at a higher NPV than in Table  6.2,
because that table ignored the additional present value of accelerated depreciation.
There is one possible additional problem lurking in the woodwork behind Table 6.5: In the
United States there is an alternative minimum tax, which can limit or defer the tax shields of
accelerated depreciation or other tax preference items. Because the alternative minimum tax
can be a motive for leasing, we discuss it in Chapter 25, rather than here. But make a mental
note not to sign off on a capital budgeting analysis without checking whether your company is
subject to the alternative minimum tax.

BEYOND THE PAGE

mhhe.com/brealey12e

The value of

MACRS tax

savings

❱ TABLE 6.4 Tax

depreciation allowed under

the modified accelerated

cost recovery system

(MACRS) (figures in percent of

depreciable investment).

Notes:

1. Tax depreciation is lower in the first and
   last years because assets are assumed to
   be in service for only six months.


2. Real property is depreciated straight-line
   over 27.5 years for residential property
   and 39 years for nonresidential property.

1 2 3 4 5 6 7 8 9

10

11

12

13

14

15

16

17

18

6

1

2

3

4

5

11

12

13

14

15

16

17-20

21

9

10

7

8

Tax Depreciation Schedules by Recovery-Period Class

44.45

33.33

14.81

7.41

32.00

20.00

19.20

11.52

11.52

5.76

24.49

14.29

17.49

12.49

8.93

8.92

4.46

8.93 5.90

18.00

10.00

14.40

11.52

9.22

7.37

6.55

6.56

6.55

6.55

3.28

9.50

5.00

8.55

7.70

6.93

6.23

5.90

5.91

5.90

5.91

5.90

5.91

5.90

5.91

2.95

7.22

6.68

6.18

5.71

5.28

4.52

4.89

4.46

4.46

4.46

4.46

4.46

4.46

4.46

4.46

4.46

2.23

3.75

Year(s) 3-year 5-year 7-year 10-year 15-year 20-year

❱ TABLE 6.5 Tax payments on IM&C’s guano project ($ thousands).

a From Table 6.1.

b Salvage value is zero, for tax purposes, after all tax depreciation has been taken. Thus, IM&C will have to pay tax on the full salvage value of $1,949.

c A negative tax payment means a cash inflow, assuming IM&C can use the tax loss on its guano project to shield income from other projects.

1 2 3 4 5 6

01234567

Period

4,000

• 4,000
  Tax at 35%c –1,400 682

Salesa

Cost of goods solda

Other costsa

Tax depreciation

Pretax profit (1 – 2 – 3 – 4)

837

523

2,200

2,000

• 4,514


• 1,580

7,729

12,887

1,210

3,200

748

262

19,552

32,610

1,331

1,920

9,807

3,432

29,345

48,901

1,464

1,152

16,940

5,929

21,492

35,834

1,611

1,152

11,579

4,053

11,830

1,772

576

5,539

1,939

19,717

1,949b