The MakeStuff Company's earnings stream is highly dependent on the cost of a key commodity input. Management believes taxable earnings will be $100,000 if the input price is low, taxable earnings will be $50,000 if the input price is at a moderate level, but earnings will be zero if the input price is high. Management sees these outcomes as being equally likely. The company pays a 15% tax rate on the first $50,000 of taxable earnings, and a 25% rate on all earnings above $50,000.
-What is MakeStuff's tax liability if the input price is at the moderate level?

Question

Quizplus · Accepted Answer

If the input price is at a moderate level, taxable earnings are $50,000. The tax rate on the first $50,000 is 15%, so the tax liability is $50,000 * 0.15 = $7,500.

The MakeStuff Company's Earnings Stream Is Highly Dependent on the Cost