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Exam 3: Taxes As Transaction Costs

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Question 21

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

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.

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Question 22

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Ms. Lenz has $100,000 in an investment paying 9% annual interest. Her marginal tax rate is 25%. Which of the following statements is false?

A) Ms. Lenz's annual before-tax cash flow from this investment is $9,000.
B) If the interest is tax-exempt, Ms. Lenz's annual after-tax cash flow is $9,000.
C) If the interest is taxable, Ms. Lenz's annual after-tax cash flow is $6,750.
D) None of these choices are false.

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Question 23

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Mr. Basel made an investment that will generate the following cash flows over a three-year period. $\begin{array}{lccc} & \text { Year } 0 & \text { Year } 1 & \text { Year } 2 \\\text { Taxable revenue } & 16,000 & 23,000 & 33,000 \\\text { Deductible expenses } & (5,000) & (6,000) & (7,500) \\\text { Nondeductible expenses } & (1,200) & (2,000) &(4,300) \end{array}$ If Mr. Basel's marginal tax rate over the three-year period is 20% and he uses a 6% discount rate, compute the NPV of the transaction using the appropriate present value tables in Appendix A (round the final answer to the nearest whole dollar) .

Private market transactions create an opportunity for bilateral tax planning.

Ms. Card bought an investment that will generate the following cash flows over a three-year period. $\begin{array}{lrrr} & \text { Year } 0 & \text { Year } & \text { Year 2 } \\\text { Taxable revenue } & 42,000 & 56,000 & 80,000 \\\text { Nontaxable revenue } & 6,000 & 8,500 & 9,000 \\\text { Deductible expenses } & (20,000) & (20,000) & (25,000) \end{array}$ If Ms. Card's marginal tax rate over the three-year period is 40% and she uses a 6% discount rate, compute the NPV of the transaction using the appropriate present value tables in Appendix A (round the final answer to the nearest whole dollar) .

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

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?

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

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

Leto Inc. has $500,000 in an investment paying 8% annual taxable interest. Each year, the corporation incurs a $3,000 nondeductible cash expense relating to the investment. If Leto's marginal tax rate is 35%, compute the annual after-tax cash flow.

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

XYT Company engaged in a transaction that generated $50,000 cash deposited in the company bank account and required the company to pay $12,000 out of that account. XYT's marginal tax rate is 30%. Which of the following statements 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 using Appendix A.

Which of the following statements about different tax rates over time is false?

Mr. Quest plans to engage in a transaction that will generate $10,000 cash flow in year 0, year 1, and year 2 ($30,000 total cash flow) . Which of the following statements is true?

KRU Company engaged in a current-year transaction that required a $20,000 cash outflow. Which of the following statements is true?

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

Mrs. Biggs invested in a business that will generate the following cash flows over a three-year period. $\begin{array}{lccc}& \text { Year } 0 & \text { Year } & \text { Year 2 } \\\text { Taxable revenue } & 30,000 & 45,000 & 70,000 \\\text { Deductible expenses } & (15,000) & (15,000) & (20,000) \\\text { Nondeductible expenses } & (1,000) & (4,000) & (10,000) \end{array}$ If Mrs. Biggs' marginal tax rate over the three-year period is 30% and she uses a 6% discount rate, compute the NPV of the transaction using the appropriate present value tables in Appendix A.

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

A business strategy that reduces the tax cost of a transaction always increases the NPV of the transaction.