CAPITAL GAINS AND AFTER-TAX INTERNAL RATES OF RETURN

Net present value models are constructed by discounting the after-tax cash flows of a challenging investment by the after-tax internal rates of return (IRRs) of a defending investment. After-tax IRRs calculated for a defending investment are shown to depend on the defender's capital gains and allowable depreciation. The often recommended adjustment to the before-tax IRRs of one minus the marginal income tax rate is not generally applicable. Failure to correctly adjust the discount rates (the defender's IRRs) for taxes may result in incorrect inferences from comparative static models and incorrect investment valuations from empirical models. Tax rate adjustments for farmland, stocks, and bonds are shown to be different and to have varied over time.