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

To calculate NPV, we need to discount each cash flow at a rate of 6% and then sum them up. 
Year 1: 15,000/(1+0.06)^1 = $14,150.94
Year 2: 18,000/(1+0.06)^2 = $15,663.50
Year 3: 20,000/(1+0.06)^3 = $16,969.03

NPV = -22,500 + $14,150.94 + $15,663.5 + $16,969.03 = $84,964.47

Since Ms. Card's marginal tax rate is 40%, we assume that she will pay taxes on the cash flows received. However, the problem does not provide us with any information on the tax treatment of the investment, such as whether it generates interest income or capital gains. Hence, we cannot adjust the cash flows for taxes and will use the pretax cash flows to calculate NPV.

Question 2

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 generated $34,000 after-tax cash flow (not $35,000 as stated in option B). This is calculated as:

Taxable income = $50,000
Tax on income (at 30%) = $15,000
After-tax income = $35,000
Less: Nondeductible payment = $12,000
After-tax cash flow = $23,000
Adding back the tax benefit of the nondeductible payment: $23,000 + $3,000 = $26,000

Therefore, option B is false as it states a wrong after-tax cash flow amount.

Question 3

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 4

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

Accepted Answer

Retroactive tax legislation creates uncertainty for taxpayers who may have already filed their taxes based on the previous tax laws. This can lead to confusion and potential errors in tax reporting and compliance, increasing tax law uncertainty.

Question 5

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 6

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 7

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 the tax law creates uncertainty for taxpayers as to how to plan and calculate their taxes for those specific years. This increases tax law uncertainty, as taxpayers may not know how to properly comply with the new law or may face unexpected changes after the law expires. The other options (market risk, financial risk, and audit risk) are not directly affected by a temporary change in the tax law.

Question 8

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 9

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 income from the investment is $50,000 x 10% = $5,000. Her annual expense is $600. So her pre-tax cash flow is $5,000 - $600 = $4,400. 
Since her marginal tax rate is 20%, her after-tax cash flow will be $4,400 x (1-0.20) = $3,520. 
However, if the interest is taxable but the expense is not deductible, her taxable income will be $5,000 - $600 = $4,400. Her tax liability will be $4,400 x 0.20 = $880. 
So her after-tax cash flow will be $4,400 - $880 = $3,520. 
Therefore, option B is correct.

Question 10

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 11

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

Let x be the marginal tax rate.
After-tax cash flow from transaction 1 = $160,000(1-x)
After-tax cash flow from transaction 2 = $120,000
Set these two equal and solve for x:
$160,000(1-x) = $120,000
160,000 - 160,000x = 120,000
40,000 = 160,000x
x = 0.25 or 25%

Therefore, if the marginal tax rate is 25% or higher, transaction 2 would generate more after-tax cash flow and would be the better choice. If the marginal tax rate is less than 25%, transaction 1 would generate more after-tax cash flow and would be the better choice.

Question 12

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 13

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

Accepted Answer

This statement is false because NPV calculations can and do use different tax rates for each future period. The estimated tax rates for each period can be based on current tax laws and future expectations, but they are not required to be constant. Therefore, choice C is incorrect. Choices A, B, and D are all true.

Question 14

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 from this investment can be calculated by multiplying the initial investment by the annual interest rate. Thus, $200,000 x 0.08 = $16,000. Therefore, statement A is true.
B) If the interest is tax-exempt, Ms. Kent does not have to pay taxes on the interest earned. Therefore, her after-tax cash flow will still be $16,000. Statement B is also true.
C) If the interest is taxable, Ms. Kent's after-tax cash flow can be calculated by taking her before-tax cash flow ($16,000) and multiplying it by (1 - marginal tax rate) = (1 - 0.4) = 0.6. Thus, her after-tax cash flow would be $16,000 x 0.6 = $9,600. Statement C is false.
D) Since statement C is false, the correct answer is D, as none of the above statements are false.

Question 15

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 16

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

Accepted Answer

If a taxpayer chooses to take advantage of an ambiguous tax issue, they create a higher audit risk. The ambiguity of the tax issue makes it more likely that the IRS will scrutinize the return, leading to an audit. The financial risk may or may not be affected by the decision, depending on whether the uncertain tax issue results in a tax savings or a tax liability. The decision likely does not affect tax law uncertainty or marginal tax rate uncertainty.

Question 17

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 18

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

The answer of Mrs. Biggs invested in a business that...

Question 19

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 20

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

If the cash flow is not taxable income, there will be no impact on Mr. Quest's taxes and the before-tax and after-tax cash flows will be equal. Therefore, option A is true. Option B is false as the NPV calculation takes into account the discount rate and the time value of money, and thus, the total cash flow does not directly determine the NPV. Option C is also false as the discount rate is determined by the risk and opportunity cost of the investment and not necessarily the tax rate.

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.