Exam 3: Taxes As Transaction Costs

Citran Company will earn $150,000 revenue as payment for a three-year consulting engagement. Compute the NPV of the revenue if Citran will receive $35,000 cash immediately (year 0), $35,000 cash next year (year 1) and $80,000 cash the following year (year 2). Citran will report the revenue as taxable income in the year received. Its marginal tax rate is 30%, and it uses an 8% discount rate.

Tax law uncertainty is the risk that the Internal Revenue Service will challenge a taxpayer's tax treatment on audit.

Ms. Owen purchased 2,000 shares of General Electric common stock through her broker. This purchase is an example of a:

Use the present value tables included in Appendix B of your textbook to compute the NPV of four $25,000 payments received in years 0, 1, 2, and 3 at a 5% discount rate.

The present value of a dollar available in a future period increases as the discount rate increases.

Arm's length business transactions can occur in:

A dollar available today is always worth more than a dollar not available until a future period.

Use the present value tables included in Appendix A of your textbook 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.

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?

Mrs. Scott loaned $100,000 to her daughter Evelyn, who agreed to pay her mother $3,000 annual interest on the debt. This loan is an example of a/an:

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. A. Wilson's marginal tax rate is 10% and the annual expense is not deductible. B. Wilson's marginal tax rate is 35% and the annual expense is deductible. C. Wilson's marginal tax rate is 25% and one-half of the annual expense is deductible.

Which of the following statements about marginal tax rates is false?

Mr. Wills invested in a business that will generate $75,000 annual after-tax cash flow in years 0 and 1 and $90,000 annual after-tax cash flow in years 2 and 3. Compute the NPV of these cash flows at a 10% discount rate.

The tax savings from a deduction decreases as the taxpayer's marginal tax rate increases.

The tax cost of a transaction represents a cash inflow.

Mr. Vail made an offer to purchase a business for sale by Mr. Craig. Mr. Vail and Mr. Craig had never met prior to their negotiation of the terms of the sale. The sale is an example of a/an:

A cash flow consisting of a constant dollar amount to be received for a specific number of future periods is called an annuity.

Ms. Teague incurred a $35,000 expense. If her marginal tax rate is 20%, which of the following statements is true?

Borden Company has the choice between two investments. Investment 1 will generate a $27,000 deductible loss this year (year 0), $15,000 taxable income in year 1, and $60,000 taxable income in year 2. Investment 2 will generate $16,000 taxable income in years 0, 1, and 2. Assume that income and loss reflect before-tax cash flow for Borden. Which opportunity should Borden choose if it has a 35% marginal tax rate and uses a 7% discount rate to compute NPV?