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Question - Firm Z, a corporation with a 21 percent tax rate, has $100,000 to invest in year 0 and two investment choices. Investment 1 will generate $12,000 taxable cash flow annually for years 1 through 5. In year 5, the firm can sell the investment for $100,000. Investment 2 will not generate any taxable income or cash flow in years 1 through 5, but in year 5, the firm can sell Investment 2 for $165,000.
Required -
a-1. Assuming a 6 percent discount rate, compute the NPV of Firm Z for each of the investments.
a-2. Which investment should Firm Z take?
b-1. Compute the NPV of Investment 2 if Firm Z is a non-corporate taxpayer with a 35 percent tax rate and the gain on sale of Investment 2 is eligible for the 15 percent capital gains rate.
b-2. Would your answer change from requirement a-2?
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