Principles Of Taxation For Business And Investment Planning 2020 Edition
23rd Edition
ISBN: 9781259969546
Author: Sally Jones, Shelley C. Rhoades-Catanach, Sandra R Callaghan
Publisher: McGraw-Hill Education
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Question
Chapter 3, Problem 1TPC
a.
To determine
Calculate
a.
Expert Solution
Explanation of Solution
Calculate NPV of salary received by Mrs. X.
| Year 0 | Year 1 | Year 2 | NPV | |
| Before-tax cash flow | $80,000 | $80,000 | $80,000 | |
| Less: Tax cost | $(20,000) | $(32,000) | $(32,000) | |
| After-tax cash flow | $60,000 | $48,000 | $48,000 | |
| Multiply: Discount factor at 8% | - | |||
| Present value | $60,000 | $44,448 | $41,136 | $145,584 |
Working note:
Calculate tax cost.
| Year 1 | Year 2 | Year 3 | |
| Before-tax income | $80,000 | $80,000 | $80,000 |
| Multiply: Marginal tax rate | |||
| Tax cost | $20,000 | $32,000 | $32,000 |
Hence, the NPV of salary received by Mrs. X is $145,584.
Calculate NPV of salary cost to Firm B.
| Year 0 | Year 1 | Year 2 | NPV | |
| Before-tax cash flow | -$80,000 | -$80,000 | -$80,000 | |
| Add: Tax savings | $27,200 | $27,200 | $27,200 | |
| After-tax cash flow | -$52,800 | -$52,800 | -$52,800 | |
| Multiply: Discount factor at 8% | - | |||
| Present value | -$52,800 | -$48,893 | -$45,250 | -$146,943 |
Working note:
Calculate tax savings.
| Year 1 | Year 2 | Year 3 | |
| Before-tax deduction | -$80,000 | -$80,000 | -$80,000 |
| Multiply: Marginal tax rate | |||
| Tax savings | -$27,200 | -$27,200 | -$27,200 |
Hence, the NPV of salary cost to Firm B is -$146,943.
b.
To determine
Calculate net present value (NPV) of salary received by Mrs. X and NPV of salary cost to Firm B.
b.
Expert Solution
Explanation of Solution
Calculate NPV of salary received by Mrs. X.
| Year 0 | Year 1 | Year 2 | NPV | |
| Before-tax cash flow | $140,000 | $50,000 | $50,000 | |
| Less: Tax cost | $(35,000) | $(20,000) | $(20,000) | |
| After-tax cash flow | $105,000 | $30,000 | $30,000 | |
| Multiply: Discount factor at 8% | - | |||
| Present value | $105,000 | $27,780 | $25,710 | $158,490 |
Working note:
Calculate tax cost.
| Year 1 | Year 2 | Year 3 | |
| Before-tax income | $140,000 | $50,000 | $50,000 |
| Multiply: Marginal tax rate | |||
| Tax cost | $35,000 | $20,000 | $20,000 |
The NPV of salary received by Mrs. X is $158,490.
Calculate NPV of salary cost to Firm B.
| Year 0 | Year 1 | Year 2 | NPV | |
| Before-tax cash flow | -$140,000 | -$50,000 | -$50,000 | |
| Add: Tax savings | $47,600 | $17,000 | $17,000 | |
| After-tax cash flow | -$92,400 | -$33,000 | -$33,000 | |
| Multiply: Discount factor at 8% | - | |||
| Present value | -$92,400 | -$30,558 | -$28,281 | -$151,239 |
Working note:
Calculate tax savings.
| Year 1 | Year 2 | Year 3 | |
| Before-tax deduction | -$140,000 | -$50,000 | -$50,000 |
| Multiply: Marginal tax rate | |||
| Tax savings | -$47,600 | -$17,000 | -$17,000 |
c.
To determine
Calculate net present value (NPV) of cost to Firm B under the proposal and state whether the proposal is superior to its original offer.
c.
Expert Solution
Explanation of Solution
Calculate NPV of cost to Firm B under the proposal.
| Year 0 | Year 1 | Year 2 | NPV | |
| Before-tax cash flow | -$140,000 | -$45,000 | -$45,000 | |
| Add: Tax savings | $47,600 | $15,300 | $15,300 | |
| After-tax cash flow | -$92,400 | -$29,700 | -$29,700 | |
| Multiply: Discount factor at 8% | - | |||
| Present value | -$92,400 | -$27,502 | -$25,453 | -$145,355 |
Working note:
Calculate tax savings.
| Year 1 | Year 2 | Year 3 | |
| Before-tax deduction | -$140,000 | -$45,000 | -$45,000 |
| Multiply: Marginal tax rate | |||
| Tax savings | -$47,600 | -$15,300 | -$15,300 |
Hence, NPV of cost to Firm B under the proposal is -$145,355.
Comment: The proposal is superior to its original offer as the NVP of salary cost of the proposal (-$145,355) is lower than the NVP of salary cost of the original offer (-$146,943).
d.
To determine
State whether Mrs. X should accept the original offer or the counterproposal by calculating net present value (NPV) of salary received.
d.
Expert Solution
Explanation of Solution
Calculate NPV of salary received by Mrs. X.
| Year 0 | Year 1 | Year 2 | NPV | |
| Before-tax cash flow | $140,000 | $45,000 | $45,000 | |
| Less: Tax cost | $(35,000) | $(18,000) | $(18,000) | |
| After-tax cash flow | $105,000 | $27,000 | $27,000 | |
| Multiply: Discount factor at 8% | - | |||
| Present value | $105,000 | $25,002 | $23,139 | $153,141 |
Working note:
Calculate tax cost.
| Year 1 | Year 2 | Year 3 | |
| Before-tax income | $140,000 | $45,000 | $45,000 |
| Multiply: Marginal tax rate | |||
| Tax cost | $35,000 | $18,000 | $18,000 |
Comment: Mrs. X should accept the counterproposal as the NPV of salary received of the proposal ($153,141) is higher than the NVP of salary received of the original offer ($145,584).
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Chapter 3 Solutions
Principles Of Taxation For Business And Investment Planning 2020 Edition
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