The ABC Corporation is contemplating purchasing a new computer system that would yield a before-tax return of 30 percent. The system would depreciate at a rate of 3 percent per year. The after-tax interest rate is 11 percent, the corporation tax rate is 35 percent, and a typical shareholder of ABC has a marginal tax rate of 30 percent. Assume for simplicity that there are no depreciation allowances or investment tax credits. Do you expect ABC to buy the new computer system?
What will be an ideal response?
Substituting into the formula, the user cost is (.11 + .03)/[(.65) * (.7)] = .307. The project's
return is lower than this, so the company does not proceed with the project.
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