Consider two firms,Zoe Corporation and Marley Company.Both corporations will either make $20,000 or lose $5,000 every year with equal probability.The firms' profits are perfectly negatively correlated.If the corporate tax rate is 21%,what are the total expected after-tax profits of both firms when they are two separate firms,assuming no tax-loss carryforwards or carrybacks?
A)$15,000
B)$10,800
C)$9,750
D)$4,000

Question

Quizplus · Accepted Answer

The expected profit for each firm is $7,500 before tax (0.5 * $20,000 + 0.5 * -$5,000). After a 21% tax, the expected after-tax profit for each firm is $5,925 (0.79 * $7,500). Since the firms are separate, the total expected after-tax profit is $5,925 * 2 = $11,850. However, due to the negative correlation, one firm will always make a profit and the other a loss, so the tax is only paid on the profit-making firm each year. Therefore, the total expected after-tax profit is $10,800.

Consider Two Firms,Zoe Corporation and Marley Company