PRINCIPLES OF TAXATION F/BUS.+INVEST.
PRINCIPLES OF TAXATION F/BUS.+INVEST.
22nd Edition
ISBN: 9781259917097
Author: Jones
Publisher: MCG
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Chapter 3, Problem 1TPC

a.

To determine

Calculate net present value (NPV) of salary received by Mrs. X and NPV of salary cost to Firm B.

a.

Expert Solution
Check Mark

Explanation of Solution

Calculate NPV of salary received by Mrs. X.

 Year 0Year 1Year 2NPV
Before-tax cash flow$80,000$80,000$80,000 
Less: Tax cost$(20,000)$(32,000)$(32,000) 
After-tax cash flow$60,000$48,000$48,000 
Multiply: Discount factor at 8%-× 0.926× 0 .857 
Present value$60,000$44,448$41,136$145,584

Working note:

Calculate tax cost.

 Year 1Year 2Year 3
Before-tax income$80,000$80,000$80,000
Multiply: Marginal tax rate× 0.25× 0 .40× 0 .40
Tax cost$20,000$32,000$32,000

Hence, the NPV of salary received by Mrs. X is $145,584.

Calculate NPV of salary cost to Firm B.

 Year 0Year 1Year 2NPV
Before-tax cash flow-$80,000-$80,000-$80,000 
Add: Tax savings$27,200$27,200$27,200 
After-tax cash flow-$52,800-$52,800-$52,800 
Multiply: Discount factor at 8%-× 0.926× 0 .857 
Present value-$52,800-$48,893-$45,250-$146,943

Working note:

Calculate tax savings.

 Year 1Year 2Year 3
Before-tax deduction-$80,000-$80,000-$80,000
Multiply: Marginal tax rate× 0.34× 0 .34× 0 .34
Tax savings-$27,200-$27,200-$27,200

Hence, the NPV of salary cost to Firm B is -$146,943.

b.

To determine

Calculate net present value (NPV) of salary received by Mrs. X and NPV of salary cost to Firm B.

b.

Expert Solution
Check Mark

Explanation of Solution

Calculate NPV of salary received by Mrs. X.

 Year 0Year 1Year 2NPV
Before-tax cash flow$140,000$50,000$50,000 
Less: Tax cost$(35,000)$(20,000)$(20,000) 
After-tax cash flow$105,000$30,000$30,000 
Multiply: Discount factor at 8%-× 0.926× 0 .857 
Present value$105,000$27,780$25,710$158,490

Working note:

Calculate tax cost.

 Year 1Year 2Year 3
Before-tax income$140,000$50,000$50,000
Multiply: Marginal tax rate× 0.25× 0 .40× 0 .40
Tax cost$35,000$20,000$20,000

The NPV of salary received by Mrs. X is $158,490.

Calculate NPV of salary cost to Firm B.

 Year 0Year 1Year 2NPV
Before-tax cash flow-$140,000-$50,000-$50,000 
Add: Tax savings$47,600$17,000$17,000 
After-tax cash flow-$92,400-$33,000-$33,000 
Multiply: Discount factor at 8%-× 0.926× 0 .857 
Present value-$92,400-$30,558-$28,281-$151,239

Working note:

Calculate tax savings.

 Year 1Year 2Year 3
Before-tax deduction-$140,000-$50,000-$50,000
Multiply: Marginal tax rate× 0.34× 0 .34× 0 .34
Tax savings-$47,600-$17,000-$17,000

c.

To determine

Calculate net present value (NPV) of cost to Firm B under the proposal and state whether the proposal is superior to its original offer.

c.

Expert Solution
Check Mark

Explanation of Solution

Calculate NPV of cost to Firm B under the proposal.

 Year 0Year 1Year 2NPV
Before-tax cash flow-$140,000-$45,000-$45,000 
Add: Tax savings$47,600$15,300$15,300 
After-tax cash flow-$92,400-$29,700-$29,700 
Multiply: Discount factor at 8%-× 0.926× 0 .857 
Present value-$92,400-$27,502-$25,453-$145,355

Working note:

Calculate tax savings.

 Year 1Year 2Year 3
Before-tax deduction-$140,000-$45,000-$45,000
Multiply: Marginal tax rate× 0.34× 0 .34× 0 .34
Tax savings-$47,600-$15,300-$15,300

Hence, NPV of cost to Firm B under the proposal is -$145,355.

Comment: The proposal is superior to its original offer as the NVP of salary cost of the proposal (-$145,355) is lower than the NVP of salary cost of the original offer (-$146,943).

d.

To determine

State whether Mrs. X should accept the original offer or the counterproposal by calculating net present value (NPV) of salary received.

d.

Expert Solution
Check Mark

Explanation of Solution

Calculate NPV of salary received by Mrs. X.

 Year 0Year 1Year 2NPV
Before-tax cash flow$140,000$45,000$45,000 
Less: Tax cost$(35,000)$(18,000)$(18,000) 
After-tax cash flow$105,000$27,000$27,000 
Multiply: Discount factor at 8%-× 0.926× 0 .857 
Present value$105,000$25,002$23,139$153,141

Working note:

Calculate tax cost.

 Year 1Year 2Year 3
Before-tax income$140,000$45,000$45,000
Multiply: Marginal tax rate× 0.25× 0 .40× 0 .40
Tax cost$35,000$18,000$18,000

Comment: Mrs. X should accept the counterproposal as the NPV of salary received of the proposal ($153,141) is higher than the NVP of salary received of the original offer ($145,584).

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PRINCIPLES OF TAXATION F/BUS.+INVEST.

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