Loose Leaf for Principles of Taxation for Business and Investment Planning 2019 Edition
22nd Edition
ISBN: 9781260161472
Author: Sally Jones, Shelley C. Rhoades-Catanach
Publisher: McGraw-Hill Education
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Question
Chapter 3, Problem 1TPC
a.
To determine
Calculate
a.
Expert Solution
Explanation of Solution
Calculate NPV of salary received by Mrs. X.
| Year 0 | Year 1 | Year 2 | NPV | |
| Before-tax | $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 1 | Year 2 | Year 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 0 | Year 1 | Year 2 | NPV | |
| 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 1 | Year 2 | Year 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
Explanation of Solution
Calculate NPV of salary received by Mrs. X.
| Year 0 | Year 1 | Year 2 | NPV | |
| 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 1 | Year 2 | Year 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 0 | Year 1 | Year 2 | NPV | |
| 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 1 | Year 2 | Year 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
Explanation of Solution
Calculate NPV of cost to Firm B under the proposal.
| Year 0 | Year 1 | Year 2 | NPV | |
| 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 1 | Year 2 | Year 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
Explanation of Solution
Calculate NPV of salary received by Mrs. X.
| Year 0 | Year 1 | Year 2 | NPV | |
| 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 1 | Year 2 | Year 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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Chapter 3 Solutions
Loose Leaf for Principles of Taxation for Business and Investment Planning 2019 Edition
Ch. 3 - Does the NPV of future cash flows increase or...Ch. 3 - Explain the relationship between the degree of...Ch. 3 - Does the after-tax cost of a deductible expense...Ch. 3 - Prob. 4QPDCh. 3 - Prob. 5QPDCh. 3 - Prob. 6QPDCh. 3 - Prob. 7QPDCh. 3 - Which type of tax law provision should be more...Ch. 3 - In the U.S. system of criminal justice, a person...Ch. 3 - Identify two reasons why a firms actual marginal...
Ch. 3 - Prob. 11QPDCh. 3 - Prob. 12QPDCh. 3 - Prob. 1APCh. 3 - Prob. 2APCh. 3 - Prob. 3APCh. 3 - Use a 5 percent discount rate to compute the NPV...Ch. 3 - Consider the following opportunities: Opportunity...Ch. 3 - Prob. 6APCh. 3 - Refer to the income tax rate structure in the...Ch. 3 - Prob. 8APCh. 3 - Company N will receive 100,000 of taxable revenue...Ch. 3 - Prob. 10APCh. 3 - Investor B has 100,000 in an investment paying 9...Ch. 3 - Firm E must choose between two alternative...Ch. 3 - Company J must choose between two alternate...Ch. 3 - Firm Q is about to engage in a transaction with...Ch. 3 - Corporation ABC invested in a project that will...Ch. 3 - Prob. 16APCh. 3 - Investor W has the opportunity to invest 500,000...Ch. 3 - Prob. 18APCh. 3 - Prob. 19APCh. 3 - Prob. 20APCh. 3 - Prob. 21APCh. 3 - Prob. 1IRPCh. 3 - Firm V must choose between two alternative...Ch. 3 - Prob. 3IRPCh. 3 - Refer to the facts in problem 3. Company WB is...Ch. 3 - Prob. 5IRPCh. 3 - Prob. 6IRPCh. 3 - Prob. 7IRPCh. 3 - Prob. 8IRPCh. 3 - Prob. 9IRPCh. 3 - Prob. 1TPCCh. 3 - Firm D is considering investing 400,000 cash in a...
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