Exam 3: Taxes As Transaction Costs

Rarke Company must choose between two alternate transactions. Transaction 1 requires a $20,000 nondeductible cash outlay, while transaction 2 requires a $25,000 deductible cash outlay. Determine the marginal tax rate at which the after-tax costs of the two transactions are equal.

Every business transaction results in a current tax cost or tax savings.

Marginal rate uncertainty includes the risk that Congress will change tax rates, increasing the tax costs of future income.

When the tax law applies differentially to transaction alternatives, decisions should focus on before-tax earnings.

Late in the current year, Jolsen Company signed a four-year contract with an advertising agency. Under the contract, Jolsen must pay $375,000 annually for the agency's services. After Jolsen signed the contract, Congress enacted legislation disallowing any deduction for advertising expense for future tax years. Jolsen underestimated the after-tax cost of the contract because of:

Arm's length business transactions can occur in:

TallBoy Inc. is a local furniture manufacturer and Leley Company is a retail furniture store. The two companies have no owners in common. Leley recently negotiated to purchase $845,000 of furniture from TallBoy. This purchase is an example of a/an:

Use the present value tables in Appendix A to compute the NPV of $8,400 received in year 0, $4,950 received in year 1, and $3,000 received in year 2 at a 7% discount rate.

Mr. Trail engaged in a current-year transaction generating $50,000 cash but only $40,000 taxable income. If Mr. Trail's marginal tax rate is 40%, compute his after-tax cash flow from the transaction.

Zazu Company is considering modifying a transaction to reduce the current year tax cost by $50,000. Which of the following statements is false?

When the IRS audits a tax return, it is most likely to scrutinize the tax consequences of a/an:

Unlow Inc. must choose between two alternate transactions. Transaction 1 would generate $160,000 cash, all of which would be taxable, while transaction 2 would generate $120,000 cash, none of which would be taxable. Determine the marginal tax rate at which the after-tax cash flows from the two transactions are equal.

Wilson Company has $100,000 in an investment paying 6% per annum. Each year Wilson incurs $1,200 of expenses related to this investment. Compute Wilson's annual net cash flow from this investment assuming the following. Wilson's marginal tax rate is 10% and the annual expense is not deductible.Wilson's marginal tax rate is 35% and the annual expense is deductible.Wilson's marginal tax rate is 25% and one-half of the annual expense is deductible.

Yawl Inc. must choose between two business opportunities: Opportunity 1 will generate $40,000 before-tax cash flow in years 0, 1, and 2, with a $7,000 annual tax cost. Opportunity 2 will also generate $40,000 before-tax cash flow in years 0, 1, and 2. However, the tax cost will be $15,000 in year 0, $2,500 in year 2, and $2,500 in year 3. Which opportunity should Yawl choose if it uses a 6% discount rate to compute NPV (round the calculations to the nearest whole dollar)?

Mr. and Mrs. Rath invested in a business that will generate the following cash flows over a three-year period. Year0 Year1 Year 2 Taxable revenue 30,000 40,000 60,000 Deductible expenses (15,000) (15,000) (20,000 If the Raths' marginal tax rate over the three-year period is 20% and they use a 6% discount rate, compute the NPV of the transaction using the appropriate present value tables in Appendix A.

Mr. and Mrs. Dean own an investment that generated $60,000 cash revenue and required $12,000 cash expenses this year. The Deans' marginal tax rate is 25%. Which of the following statements is true?

Pepper Company, which has a 25% marginal tax rate, must choose between two alternative transactions. Transaction 1 requires a $20,400 cash outlay that is a deductible current expense. Transaction 2 requires a $15,000 cash outlay that is a nondeductible current expense. Which transaction has the lesser after-tax cost to Pepper?

Hower Inc.'s tax advisor recommends that the corporation take a deduction that the IRS has disallowed for other corporations in similar circumstances. If Hower decides not to take the deduction, it is reducing:

If a taxpayer decides to take advantage of an ambiguous tax issue to reduce future tax costs, the decision increases: