Question

Company J must choose between two alternative business expenditures with the following cash flows:

Expenditure 1: $80,000 cash outflow
Expenditure 2: $60,000 cash outflow

Required:
a. Determine the marginal tax rate at which the after-tax cash flows from the two expenditures are equal assuming that Expenditure 1 is fully deductible and Expenditure 2 is non deductible.
b. Determine the marginal tax rate at which the after-tax cash flows from the two expenditures are equal assuming that Expenditure 1 is 50 percent deductible and Expenditure 2 is nondeductible.
c. Determine the marginal tax rate at which the after-tax cash flows from the two expenditures are equal assuming that Expenditure 1 is fully deductible and Expenditure 2 is 50 percent deductible.

Answer 1

A. 25%

B. 50%

C. 40%

Step-by-step explanation:

A. Calculation to determine the marginal tax rate assuming that Expenditure 1 is fully deductible and Expenditure 2 is non deductible

Lets marginal tax rate be X%

Marginal tax rate =$80,000 - [$80,000*X%] = 60,000$

Marginal tax rate =$80,000*X% = $80,000-$60,000

Marginal tax rate =$80,000*X% =$20,000

Marginal tax rate =X= $20,000/$80,000

Marginal tax rate =X= 25%

Therefore the marginal tax rate assuming that Expenditure 1 is fully deductible and Expenditure 2 is non deductible will be 25%

b. Calculation to Determine the marginal tax rate

assuming that Expenditure 1 is 50 percent deductible and Expenditure 2 is nondeductible.

Marginal tax rate=$80,000 - [$80,000*50%*X%] =$ 60,000

Marginal tax rate=$40,000*X%=$20,000

Marginal tax rate=X%=50%

Therefore the marginal tax rate

assuming that Expenditure 1 is 50 percent deductible and Expenditure 2 is nondeductible will be 50%

c.Calculation to determine the marginal tax assuming that Expenditure 1 is fully deductible and Expenditure 2 is 50 percent deductible.

Marginal tax rate=$80,000- [$80,000*X] = $60,000 - [$60,000*50%*X]

Marginal tax rate=$80,000-$60,000 = [$80,000*x] - [$30,000*x]

Marginal tax rate=$20,000 =$50,000X

Marginal tax rate=X=$20,000/$50,000

Marginal tax rate=X=40%

Therefore the marginal tax assuming that Expenditure 1 is fully deductible and Expenditure 2 is 50 percent deductible will be 40%