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?

Question

Quizplus · Accepted Answer

First, we need to calculate Ms. Leik's annual before-tax cash flow:

Annual interest income = $50,000 x 10% = $5,000

Annual expense = $600

Annual before-tax cash flow = $5,000 - $600 = $4,400

Next, we need to calculate Ms. Leik's annual after-tax cash flow based on the information given:

Taxable income = $5,000 - $600 = $4,400

Tax on taxable income = $4,400 x 20% = $880

Annual after-tax cash flow = $4,400 - $880 = $3,520

So, choice A is incorrect.

Now, let's consider the tax implications of the investment income and expense:

If the interest income is taxable but the expense is not deductible, Ms. Leik's taxable income will be:

$5,000 - $0 = $5,000

Tax on taxable income = $5,000 x 20% = $1,000

Annual after-tax cash flow = $5,000 - $1,000 - $600 = $3,400

Therefore, choice B is correct.

If the interest income is tax-exempt and the expense is not deductible, Ms. Leik's taxable income will be:

$0 - $600 = -$600 (negative taxable income)

Since Ms. Leik cannot have negative taxable income, choice C is incorrect.

Therefore, the only correct choice is B.

Ms Leik Has $50,000 in an Investment Paying 10% Annual