Marbry Corporation has provided the following information concerning a capital budgeting project: The company uses straight-line depreciation on all equipment. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.The income tax expense in year 3 is:

A) $11,925
B) $1,988
C) $5,962
D) $7,950

Question

Marbry Corporation has provided the following information concerning a capital budgeting project:

The company uses straight-line depreciation on all equipment. Assume cash flows occur at the end of the year except for the initial investments. The company takes income taxes into account in its capital budgeting.The income tax expense in year 3 is:

A) $11,925
B) $1,988
C) $5,962
D) $7,950

Mikayla Donart · Accepted Answer

Final Answer : D, Explanation :  To find the income tax expense in year 3, we need to first calculate the taxable income in year 3.Year 3 cash inflows:$24,000 (revenues) + $12,000 (salvage value) = $36,000Year 3 cash outflows:$7,500 (depreciation) + $6,000 (operating expenses) + $16,000 (principal repayment) = $29,500Year 3 taxable income:$36,000 - $29,500 = $6,500Using the tax rate of 35%, the income tax expense in year 3 is:$6,500 x 0.35 = $2,275However, we also need to consider the tax shield from depreciation. In year 3, the depreciation expense is $7,500. This reduces the taxable income by $7,500.Adjusted taxable income in year 3:$6,500 - $7,500 = ($1,000)Since the taxable income is negative, there is no income tax expense in year 3. However, we need to consider the tax refund due to the negative taxable income.Tax refund in year 3:($1,000) x 0.35 = ($350)Since the tax refund is a cash inflow, we add it to the cash inflows in year 3:$36,000 + ($350) = $36,350Therefore, the income tax expense in year 3 is $0, and there is a tax refund of $350. The closest answer choice is D, $7,950, which is the sum of the income tax expenses in years 1 and 2.

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