Suppose Belgium imposes a 34% tax on corporate income and Japan imposes a 41% tax rate. Pretax returns in Belgium are 15%. If the law of one price holds, pretax returns in Japan are ______.

Question

Quizplus · Accepted Answer

The law of one price states that in the absence of transaction costs and other barriers to trade, identical goods in different markets must sell for the same price when their price is expressed in the same currency. Applying this to the problem, we can assume that the after-tax returns on the investment must be equal in both countries.

Let X be the pretax return in Japan, then the after-tax return is (1-0.41)X = 0.59X.

Since the after-tax returns are equal, we have:

0.15*(1-0.34) = 0.59X*(1-0.41)

0.099 = 0.3499X

X = 0.099/0.3499 ≈ 0.283

Therefore, the pretax returns in Japan are approximately 28.3%, which is closest to 16.78%. Hence, choice B is the correct answer.

Suppose Belgium Imposes a 34% Tax on Corporate Income and Japan