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Company P must choose between two alternate transactions. The cash generated by Transaction 1 is taxable and the cash generated by Transaction 2 is nontaxable. Determine the marginal tax rate at which the after-tax cash flows from the two transactions are equal assuming that:

a. Transaction 1 generates $100,000 of income and Transaction 2 generates $60,000 of income.

b. Transaction 1 generates $160,000 of income and Transaction 2 generates $120,000 of income.

Respuesta :

TomShelby

Answer:

A 40%

B 25%

Explanation:

We need the tax rate which equal the cash flow of transaction 1 with transaction 2

That way, transaction 1 is the before tax

and transaction 2 is the after tax

transaction 1 X (1 - t) = Transaction 2

before tax X (1-t)  = after tax

we clear for tax rate and reach this formula:

[tex]\frac{before \:tax - after \:tax }{before \: tax} =$Tax Rate[/tex]

Now we post the values on the formula and solve for each alternative

A

[tex]\frac{100,000 - 60,000 }{100,000} =$Tax Rate[/tex]

Tax rate = 40%

B

[tex]\frac{160,000 - 120,000 }{160,000} =$Tax Rate[/tex]

Tax rate = 25%

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