Question 1

The tax cost of an income-generating transaction increases as the taxpayer's marginal tax rate increases.

Accepted Answer

A) True 
 B)False  True

Question 2

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

Accepted Answer

A)   A taxpayer's marginal rate does not change over time.
B)   As the marginal rate decreases, the after-tax cost of a deductible expense increases.
C)   As the marginal rate decreases, the after-tax value of an income-generating transaction increases.
D)   Both a taxpayer's marginal rate does not change over time and, as the marginal rate decreases, the after-tax cost of a deductible expense increases. A

Question 3

Reid Inc. received a $90,000 cash payment, only $50,000 of which was taxable income. If Reid's marginal tax rate is 40%, compute Reid's after-tax cash flow.

Accepted Answer

A)   $54,000
B)   $50,000
C)   $30,000
D)   None of the above D

Question 4

Mr and Mrs Bing purchased a business from Ms. Clark in an arm's length transaction. This transaction occurred in a private market.

Accepted Answer

A) True 
 B)False

Question 5

The tax savings from a transaction represents a cash inflow.

Accepted Answer

A) True 
 B)False

Question 6

The IRS scrutinizes related party transactions more carefully than transactions occurring in a public market.

Accepted Answer

A) True 
 B)False

Question 7

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.

Accepted Answer

The answer of Wilson Company has $100,000 in an investment...

Question 8

Which of the following statements about related party transactions is false?

Accepted Answer

A)   The transaction may lack the economic tension characteristic of a transaction between unrelated parties.
B)   The transaction may reflect a fictitious market.
C)   The parties to the transaction may have compatible financial objectives.
D)   None of the above is false.

Question 9

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. Use Appendix A to determine which opportunity Borden should choose if it has a 35% marginal tax rate and uses a 7% discount rate to compute NPV?

Accepted Answer

The answer of Borden Company has the choice between two...

Question 10

Net cash flow from a transaction equals the difference between cash received and cash disbursed in the transaction.

Accepted Answer

A) True 
 B)False

Question 11

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

Accepted Answer

A) True 
 B)False

Question 12

Holter Inc. owns an investment that generated $120,000 cash revenue and required $26,500 cash expenses this year. Holter's marginal tax rate is 30%. Which of the following statements is false?

Accepted Answer

A)   Holter's before-tax cash flow is $93,500.
B)   If the revenue is taxable, but only $19,000 of the expenses are deductible, Holter's after-tax cash flow is $63,200.
C)   If only $105,000 of the revenue is taxable, but all the expenses are deductible, Holter's after-tax cash flow is $69,950.
D)   None of the above is false.

Question 13

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

Accepted Answer

A)   Related party transaction
B)   Private market transaction
C)   Public market transaction
D)   Arm's length transaction

Question 14

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.

Accepted Answer

A)   $20,000
B)   $24,000
C)   $34,000
D)   $40,000

Question 15

Citran Company will earn $150,000 revenue as payment for a three-year consulting engagement. Compute the NPV of the revenue using Appendix A if Citran will received $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.

Accepted Answer

The answer of Citran Company will earn $150,000 revenue as...

Question 16

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

Accepted Answer

A)   A taxpayer's marginal rate can change with every transaction.
B)   As the marginal rate increases, the tax cost of an income-generating transaction decreases.
C)   As the marginal rate increases, the tax savings from a deduction increases.
D)   Both a taxpayer's marginal rate can change with every transaction and, as the marginal rate increase, the tax savings from a deduction increases.

Question 17

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:

Accepted Answer

A)   Related party transaction
B)   Public market transaction
C)   Arm's length transaction
D)   None of the above

Question 18

Omar Inc. paid a $24,000 expense, only $10,000 of which was deductible. Which of the following statements is false?

Accepted Answer

A)   If Omar's marginal tax rate is 10%, the after-tax cost of the expense is $9,000.
B)   Regardless of Omar's marginal tax rate, the before-tax cost of the expense is $24,000.
C)   If Omar's marginal tax rate is 30%, the after-tax cost of the expense is $21,000.
D)   The after-tax cost of the expense depends on Omar's marginal tax rate.

Question 19

Use the present value tables included in Appendix A of your textbook to compute the NPV of $12,500 received in year 5 at a 6% discount rate.

Accepted Answer

A)   $8,745.50
B)   $9,337.50
C)   $9,900.00
D)   None of the above

Question 20

The tax cost of a transaction depends on the taxpayer's average tax rate for the year.

Accepted Answer

A) True 
 B)False

Exam 3: Taxes as Transaction Costs

The tax cost of an income-generating transaction increases as the taxpayer's marginal tax rate increases.

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

Reid Inc. received a $90,000 cash payment, only $50,000 of which was taxable income. If Reid's marginal tax rate is 40%, compute Reid's after-tax cash flow.

Mr and Mrs Bing purchased a business from Ms. Clark in an arm's length transaction. This transaction occurred in a private market.

The tax savings from a transaction represents a cash inflow.

The IRS scrutinizes related party transactions more carefully than transactions occurring in a public market.

Which of the following statements about related party transactions is false?

Net cash flow from a transaction equals the difference between cash received and cash disbursed in the transaction.

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

Holter Inc. owns an investment that generated $120,000 cash revenue and required $26,500 cash expenses this year. Holter's marginal tax rate is 30%. 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:

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.

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

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:

Omar Inc. paid a $24,000 expense, only $10,000 of which was deductible. Which of the following statements is false?

Use the present value tables included in Appendix A of your textbook to compute the NPV of $12,500 received in year 5 at a 6% discount rate.

The tax cost of a transaction depends on the taxpayer's average tax rate for the year.