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Generally Accepted Accounting Principles Essay

11. a. Year 0 Year 1 Year 2 Year 3 Year 4
Before-tax cash flow $(500,000) $52,500 $47,500 $35,500 $530,500
Tax cost (7,875) (7,125) (5,325) (4,575)
After-tax cash flow 44,625 40,375 30,175 525,925 Discount factor (7%) .935 .873 .816 .763
Present value $(500,000) $41,724 $35,247 $24,623 $401,281
NPV $2,875
Investor W should make the investment because NPV is positive.

b. Year 0 Year 1 Year 2 Year 3 Year 4
Before-tax cash flow $(500,000) $52,500 $47,500 $35,500 $530,500 Tax cost (10,500) (9,500) (7,100) (6,100) After-tax cash flow 42,000 38,000 28,400 524,400 Discount factor (7%) .935 .873 .816 .763

Present value $(500,000) $39,270 $33,174 $23,174 $400,117
NPV $(4,265)
Investor W should not make the investment because NPV is negative.

c. Year 0 Year 1 Year 2 Year 3 Year 4
Before-tax cash flow $(500,000) $52,500 $47,500 $35,500 $530,500 Tax cost (5,250) (4,750) (8,875) (7,625) After-tax cash flow 47,250 42,750 26,625 522,875 Discount factor (7%) .935 .873 .816 .763
Present value $(500,000) $44,179 $37,321 $21,726 $398,954
NPV $2,180
Investor W should make the investment because NPV is positive.

16. a. Opportunity 1: Year 0 Year 1 Year 2
Taxable income (loss) $(8,000) $5,000 $20,000
Marginal tax rate .40 .40 .40
Tax $(3,200) $2,000 $8,000
Before-tax cash flow $(8,000) $5,000 $20,000
Tax (cost) or savings 3,200(2,000) (8,000)
Net cash flow $(4,800) $3,000 $12,000
Discount factor (12%) .893 .797
Present value $(4,800) $2,679 $9,564
NPV $7,443

Opportunity 2: Year 0 Year 1 Year 2
Taxable income $5,000 $5,000 $5,000
Marginal tax rate .40 .40 .40
Tax $2,000 $2,000 $2,000
Before-tax cash flow $5,000 $5,000 $5,000
Tax (cost) or savings (2,000) (2,000) (2,000)
Net cash flow $3,000 $3,000 $3,000
Discount factor (12%) .893 .797
Present value $3,050 $2,679 $2,391
NPV $8,120
Firm E should choose opportunity 2.

b. Opportunity 1: Year 0 Year 1 Year 2
Taxable income (loss) $(8,000) $5,000 $20,000
Marginal tax rate .15 .15 .15
Tax $(1,200) $750 $3,000
Before-tax cash flow $(8,000) $5,000 $20,000
Tax (cost) or savings 1,200 (750) (3,000)
Net cash flow $(6,800) $4,250 $17,000
Discount factor (12%) .893 .797
Present value $(6,800) $3,795 $13,549
NPV $10,544

Opportunity 2: Year 0 Year 1 Year 2
Taxable income $5,000 $5,000 $5,000
Marginal tax rate .15 .15 .15
Tax $750 $750 $750
Before-tax cash flow $5,000 $5,000 $5,000
Tax (cost) or savings (750) (750) (750)
Net cash flow $4,250 $4,250 $4,250
Discount factor (12%) .893 .797
Present value $4,250 $3,795 $3,387
NPV $11,432
Firm E should choose opportunity 2.

c. Opportunity 1: Year 0 Year 1 Year 2
Taxable income (loss) $(8,000) $5,000 $20,000
Marginal tax rate .40 .15 .15
Tax $(3,200) $750 $3,000
Before-tax cash flow $(8,000) $5,000 $20,000
Tax (cost) or savings 3,200 (750) (3,000)
Net cash flow $(4,800) $4,250 $17,000
Discount factor (12%) .893 .797
Present value $(4,800) $3,795 $13,549
NPV $12,544

Opportunity 2: Year 0 Year 1 Year 2
Taxable income $5,000 $5,000 $5,000
Marginal tax rate .40 .15 .15
Tax $2,000 $750 $750
Before-tax cash flow $5,000 $5,000 $5,000
Tax (cost) or savings (2,000) (750) (750)
Net cash flow $3,000 $4,250 $4,250
Discount factor (12%) .893 .797
Present value $3,000 $3,795 $3,387
NPV $10,182
Firm E should choose opportunity 1.

1. a. (1) Year 0 Year 1 Year 2
Before-tax salary/income $80,000 $80,000 $80,000
Marginal tax rate .25 .40 .40
Tax on income $20,000 $32,000 $32,000

After-tax cash flow $60,000 $48,000 $48,000
Discount factor (8%) .926 .857
Present value $60,000 $44,448 $41,136

NPV of salary received by Mrs. X $145,584

(2) Before-tax payment /deduction $80,000 $80,000 $80,000
Marginal tax rate .34 .34 .34
Tax savings from deduction $27,200 $27,200 $27,200

After-tax cost $(52,800) $(52,800) $(52,800)
Discount factor (8%) .926 .857
Present value $(52,800) $(48,893) $(45,250)

NPV of salary cost to Firm B $(146,943)

b. (1) Year 0 Year 1 Year 2
Before-tax salary/income $140,000 $50,000 $50,000
Marginal tax rate .25 .40 .40
Tax on income $35,000 $20,000 $20,000

After-tax cash flow $105,000 $30,000 $30,000
Discount factor (8%) .926 .857
Present value $105,000 $27,780 $25,710

NPV of salary received by Mrs. X $158,490

(2) Before-tax payment /deduction $140,000 $50,000 $50,000
Marginal tax rate .34 .34 .34
Tax savings from deduction $47,600 $17,000 $17,000

After-tax cost $(92,400) $(33,000) $(33,000)
Discount factor (8%) .926 .857
Present value $(92,400) $(30,558) $(28,281)

NPV of salary cost to Firm B $(151,239)

c. Year 0 Year 1 Year 2
Before-tax payment /deduction $140,000 $45,000 $45,000
Marginal tax rate .34 .34 .34
Tax savings from deduction $47,600 $15,300 $15,300

After-tax cost $(92,400) $(29,700) $(29,700)
Discount factor (8%) .926 .857
Present value $(92,400) $(27,502) $(25,423)

NPV of salary cost to Firm B $(145,325)

This proposal is superior (has less cost) to Firm B than its original offer.

d. Year 0 Year 1 Year 2
Before-tax salary/income $140,000 $45,000 $45,000
Marginal tax rate .25 .40 .40
Tax on income $35,000 $18,000 $18,000

After-tax cash flow $105,000 $27,000 $27,000
Discount factor (8%) .926 .857
Present value $105,000 $25,002 $23,139

NPV of salary received by Mrs. X $153,141

Mrs. X should accept this counterproposal because it has
a greater NPV than Firm B’s original offer.


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