Goldmines Inc.(fictitious name)makes a pretax profit of $150 million when gold prices increase (which happens with probability 0.5)but zero otherwise.Alternatively,the company can hedge with gold futures and have a known profit of $70 million.
-Suppose that Goldmines has accumulated losses totaling $30 million.It can deduct this loss from this year's profit and thus lower its tax burden.If unutilized,this opportunity disappears.Assuming a tax rate of 30 percent,the expected after-tax profit for an unhedged firm and the after-tax profit for a hedged firm,respectively,are:

Question

Quizplus · Accepted Answer

For the unhedged firm, the expected after-tax profit would be:

$150 million * 0.5 - $30 million = $45 million (pre-tax profit minus the deductible loss)

Tax burden = 0.3 * ($150 million * 0.5) = $22.5 million

After-tax profit = $45 million - $22.5 million = $22.5 million

For the hedged firm, the after-tax profit is simply the known profit minus taxes:

After-tax profit = $70 million - (0.3 * $70 million) = $49 million

Therefore, the expected after-tax profit for the unhedged firm is $22.5 million, and for the hedged firm is $49 million. The correct answer is D.