Question 1

Ms. Card bought an investment that will generate the following cash flows over a three-year period.  If Ms. Card's marginal tax rate over the three year period is 40% and she uses a 6% discount rate, compute the NPV of the transaction.

Accepted Answer

Using the chart provided, we can calculate the present value of each cash flow using the formula:

PV = CF / (1 + r)^t

where CF is the cash flow, r is the discount rate, and t is the number of years in the future the cash flow will be received.

The table below summarizes the PV of each cash flow:

Year | Cash flow | PV @ 6%
-----|----------|---------
  1  | $30,000  | $28,301
  2  | $40,000  | $35,573
  3  | $50,000  | $41,917
Total | $120,000 | $105,791

Next, we need to adjust the total PV for taxes. Since Ms. Card's marginal tax rate is 40%, we multiply the total PV by (1 - 0.4) to get the after-tax PV:

After-tax PV = $105,791 * (1 - 0.4) = $63,474

Finally, we subtract the initial investment of $50,000 to get the net present value:

NPV = $63,474 - $50,000 = $13,474

Therefore, the answer is B) $84,964.

Question 2

Mr. Wills invested in a business that will generate $75,000 annual after-tax cash flow in years 0 and 1 and $90,000 annual after-tax cash flow in years 2 and 3. Compute the NPV of these cash flows at a 10% discount rate.

Accepted Answer

The answer of Mr. Wills invested in a business that...

Question 3

Mr. Basel made an investment that will generate the following cash flows over a three-year period.  If Mr. Basel's marginal tax rate over the three year period is 20% and he uses a 6% discount rate, compute the NPV of the transaction.

Accepted Answer

The answer of Mr. Basel made an investment that will...

Question 4

Holter Inc. owns an investment that generated $120,000 cash revenue and required $26,500 cash expenses this year. Holter's marginal tax rate is 30%. Which of the following statements is false?

Accepted Answer

The answer of Holter Inc. owns an investment that generated...

Question 5

Ms. Leik has $50,000 in an investment paying 10% annual interest. Each year, she incurs a $600 cash expense relating to the investment. If Ms. Leik's marginal tax rate is 20%, which of the following statements is true?

Accepted Answer

Ms. Leik's annual interest income is $5,000 ($50,000 x 10%). Her annual cash expense of $600 reduces her annual after-tax cash flow by $480 ($600 x 0.8). If the interest income is taxable, her tax liability will be $1,000 ($5,000 x 20%), leaving her with an annual after-tax cash flow of $3,520 ($5,000 - $480 - $1,000). If the expense is not deductible, her after-tax cash flow will be further reduced, leaving her with an annual after-tax cash flow of $3,400 ($3,520 - $120). Therefore, option B is true.

Question 6

Mrs. Biggs invested in a business that will generate the following cash flows over a three-year period.  If Mrs. Biggs' marginal tax rate over the three year period is 30% and she uses a 6% discount rate, compute the NPV of the transaction.

Accepted Answer

To calculate NPV, we need to discount each cash flow back to its present value and then sum them up.

Year 1: $30,000 / (1+0.06)^1 = $28,301.89
Year 2: $40,000 / (1+0.06)^2 = $35,478.10
Year 3: $50,000 / (1+0.06)^3 = $41,410.28

NPV = $28,301.89 + $35,478.10 + $41,410.28 - Initial Investment
NPV = $105,190.27 - $57,408.60
NPV = $47,781.67

So, the correct answer is option C, $47,781.

Question 7

Mr. and Mrs. Dean own an investment that generated $60,000 cash revenue and required $12,000 cash expenses this year. The Deans' marginal tax rate is 25%. Which of the following statements is true?

Accepted Answer

The answer of Mr. and Mrs. Dean own an investment...

Question 8

Unlow Inc. must choose between two alternate transactions. Transaction 1 would generate $160,000 cash, all of which would be taxable, while transaction 2 would generate $120,000 cash, none of which would be taxable. Determine the marginal tax rate at which the after-tax cash flows from the two transactions are equal.

Accepted Answer

To determine the marginal tax rate at which the after-tax cash flows from the two transactions are equal, we need to set up the following equation:

After-tax cash flow from Transaction 1 = After-tax cash flow from Transaction 2
$160,000(1 - marginal tax rate) = $120,000
160,000 - 160,000marginal tax rate = 120,000
40,000 = 160,000marginal tax rate
marginal tax rate = 0.25 or 25%

Therefore, the company should choose Transaction 2 if the marginal tax rate is more than 25% and should choose Transaction 1 if the marginal tax rate is less than 25%. Since we are not given any information about the company's current marginal tax rate, we cannot determine the best choice between the two options.

Question 9

Reid Inc. received a $90,000 cash payment, only $50,000 of which was taxable income. If Reid's marginal tax rate is 40%, compute Reid's after-tax cash flow.

Accepted Answer

Reid's after-tax cash flow is $70,000 ($90,000 before-tax cash - $20,000 tax cost on $50,000 income).

Question 10

Ms. Kent has $200,000 in an investment paying 8% annual interest. Her marginal tax rate is 40%. Which of the following statements is false?

Accepted Answer

A) Ms. Kent's annual before-tax cash flow = $200,000 x 8% = $16,000
B) If the interest is tax-exempt, Ms. Kent's annual after-tax cash flow is still $16,000 because there would be no tax liability.
C) If the interest is taxable, Ms. Kent's annual after-tax cash flow would be:
$16,000 - ($16,000 x 40%) = $9,600
Therefore, statement C is false. 
D) None of the above is false, except for statement C.

Question 11

XYT Company engaged in a transaction that generated $50,000 cash deposited in the company bank account and required the company to pay $12,000 out of that account. XYT's marginal tax rate is 30%. Which of the following statements is false?

Accepted Answer

If the deposit is taxable income but the payment is nondeductible, the transaction would generate $34,000 ($50,000*(1-0.3) - $12,000) after-tax cash flow, not $35,000 as stated in option B. Therefore, option B is false. Options A and C are both true. Therefore, the correct answer is B.

Question 12

Mr. Quest plans to engage in a transaction that will generate $10,000 cash flow in year 0, year 1, and year 2 ($30,000 total cash flow). Which of the following statements is true?

Accepted Answer

The answer of Mr. Quest plans to engage in a...

Question 13

If a taxpayer decides to take advantage of an ambiguous tax issue to reduce future tax costs, the decision increases:

Accepted Answer

Taking advantage of an ambiguous tax issue increases the risk of being audited by the tax authorities, as the issue may be subject to different interpretations and could be deemed non-compliant with tax laws.

Question 14

If Congress enacts a temporary change in the tax law that will apply for only two taxable years, the change increases:

Accepted Answer

A temporary change in tax law creates uncertainty for taxpayers as they may not know whether the change will be extended or not. This can lead to difficulties in tax planning and potential errors in tax compliance, increasing tax law uncertainty for taxpayers.

Question 15

Mr. and Mrs. Rath invested in a business that will generate the following cash flows over a three-year period.  If the Raths' marginal tax rate over the three year period is 20% and they use a 6% discount rate, compute the NPV of the transaction.

Accepted Answer

The answer of Mr. and Mrs. Rath invested in a...

Question 16

Hower Inc.'s tax advisor recommends that the corporation take a deduction that the IRS has disallowed for other corporations in similar circumstances. If Hower decides not to take the deduction, it is reducing:

Accepted Answer

The answer of Hower Inc.'s tax advisor recommends that the...

Question 17

Rarke Company must choose between two alternate transactions. Transaction 1 requires a $20,000 nondeductible cash outlay, while transaction 2 requires a $25,000 deductible cash outlay. Determine the marginal tax rate at which the after-tax costs of the two transactions are equal.

Accepted Answer

To determine the marginal tax rate at which the after-tax costs of the two transactions are equal, we can set up the following equation:

($25,000 - $25,000 x Marginal Tax Rate) = ($20,000 - $20,000 x Marginal Tax Rate x (1-Marginal Tax Rate))

Simplifying and solving for the marginal tax rate:

$25,000 - $25,000 x Marginal Tax Rate = $20,000 - $20,000 x Marginal Tax Rate + $20,000 x Marginal Tax Rate - $20,000 x Marginal Tax Rate^2

$5,000 = $0 + $20,000 x Marginal Tax Rate - $20,000 x Marginal Tax Rate^2

$20,000 x Marginal Tax Rate^2 - $20,000 x Marginal Tax Rate + $5,000 = 0

Solving for Marginal Tax Rate using the quadratic formula:

Marginal Tax Rate = (-(-$20,000) ± sqrt((-20,000)^2 - 4 x $20,000 x $5,000)) / (2 x $20,000)

Marginal Tax Rate = (0.25 ± 0.15)

Marginal Tax Rate = 0.10 or 0.40

Since we are looking for the marginal tax rate where the after-tax costs of the two transactions are equal, we want to choose the marginal tax rate that falls within the range of current tax rates. According to the IRS, the current marginal tax rates range from 10% to 37%, so we can eliminate the choice of 0.10.

Therefore, the best choice is B) 20%. At a marginal tax rate of 20%, the after-tax cost of Transaction 1 would be $16,000 and the after-tax cost of Transaction 2 would be $20,000, making Transaction 1 the better option.

Question 18

Leto Inc. has $500,000 in an investment paying 8% annual taxable interest. Each year, the corporation incurs a $3,000 nondeductible cash expense relating to the investment. If Leto's marginal tax rate is 35%, compute the annual after-tax cash flow.

Accepted Answer

The answer of Leto Inc. has $500,000 in an investment...

Question 19

Which of the following statements about different tax rates over time is false?

Accepted Answer

This statement is false because a NPV calculation does not have to assume a constant tax rate for all future periods. In fact, the most accurate NPV calculations take into account the possibility of changes in tax rates over time.

Question 20

If Congress enacts legislation late in the year that is retroactive to the beginning of the year, the legislation increases:

Accepted Answer

Retroactive legislation can create confusion and uncertainty regarding tax obligations for the entire year, as taxpayers may have already made decisions and taken actions based on the previous tax law. This can lead to increased tax law uncertainty. Audit risk, financial risk, and marginal tax rate uncertainty are not necessarily impacted by retroactive legislation.

Quiz 3: Taxes As Transaction Costs

Ms. Card bought an investment that will generate the following cash flows over a three-year period. If Ms. Card's marginal tax rate over the three year period is 40% and she uses a 6% discount rate, compute the NPV of the transaction.