OWB Inc.and Owin Inc.are owned by the same family.OWB's marginal tax rate is 40%,and Owin's marginal tax rate is 25%.OWB has the opportunity to engage in a transaction that will generate $250,000 taxable cash flow.Alternatively,Owin could engage in the transaction.However,Owin would incur an extra $60,000 deductible cash expense with respect to the transaction.Which of the following statements is true?

Question

Quizplus · Accepted Answer

Since OWB and Owin are owned by the same family, the taxable cash flow generated by the transaction will eventually flow to the same ultimate owners regardless of which corporation engages in the transaction. Therefore, the family's tax liability will be the same regardless of which corporation generates the taxable cash flow.

To determine which corporation should engage in the transaction, we need to calculate the after-tax cash flow for each corporation.

For OWB: 
Taxable cash flow = $250,000 
Tax at 40% = $100,000 
After-tax cash flow = $250,000 - $100,000 = $150,000

For Owin: 
Taxable cash flow = $250,000 
Extra deductible expense = $60,000 
Taxable income = $190,000 
Tax at 25% = $47,500 
After-tax cash flow = $250,000 - $47,500 = $202,500

Therefore, Owin would generate more after-tax cash flow than OWB if it incurs the extra $60,000 deductible expense.

Thus, the best choice is B: OWB should engage in the transaction to generate $7,500 more after-tax cash flow if it does not incur the extra $60,000 deductible expense that Owin would incur.

OWB IncAnd Owin Inc