Choice "C" is correct. After tax cash flows are computed based upon pre-tax cash flows, net of taxation, plus the tax shield effect of incremental non-cash expenses computed as follows: | Tax
Factor
| Given
| Pre-tax
Cash Flow
| After-tax
Cash Flow
| |
|---|
Sales | | $300,000 | | | | Variable costs | | (280,000) |
| | | Cash Inflows | | | $20,000 | | | Cash inflows net of tax | 30% | | | 14,000 | * | Initial investment | | 150,000 | | | | Useful life (years) | | ÷ 10 | | | | Depreciation expense (per year) | | | 15,000 | | | Tax protection from non-cash expense | 30% | | | 4,500 | ** | After-tax cash flows | | | | $18,500 | | * ([1 − Tax Factor] × Pre-tax Cash Flow)× $20,000 | | ** (Tax Factor × Pre-tax Cash Flow)× $15,000 | |
Choice "b" is incorrect. The after-tax cash flow is the sum of the after tax-cash inflows and the tax shield of non-cash expenses, not the difference.
Choice "d" is incorrect. The after-tax cash flows are computed using the complement of the tax rate times the inflows and the tax rate times the tax protection associated with the non-cash expenses, not the tax rate times all elements of the transaction.
Choice "a" is incorrect. The after-tax cash flows are computed using the complement of the tax rate times the inflows and the tax rate times the tax protection associated with the non-cash expenses, not complement of the tax rate times all elements of the transaction.
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