Choice "B" is correct. Project B has an after-tax cash inflow equal to $635, which is larger than the performance of Project A. The after-tax cash flows for Project A and Project B are computed as follows:
Project A | |
Annual cash inflows after tax ($1,000 − $400) × (1 − 0.3) | $ 420 |
Depreciation tax shield ($150 × 0.3) | 45 |
| Total after-tax cash flows | $ 465 |
| | |
Project B | |
Annual cash inflows after tax ($1,500 − $700) × (1 − 0.3) | $ 560 |
Depreciation tax shield ($250 × 0.3) | 75 |
| Total after-tax cash flows | $ 635 |
Choice "d" is incorrect. Although the after-tax cash flows of Project A are correctly computed in this option, they are smaller, not larger than Project B.Choice "c" is incorrect. This solution incorrectly computes the after-tax cash flows by including depreciation as a cash outflow. In addition, Project A cash inflows are less than those of Project B.Choice "a" is incorrect. Although Project B does have the largest after-tax cash inflows, this solution incorrectly computes the after-tax cash flows by including depreciation as a cash outflow.
