Firm L has $500,000 to invest and is considering two alternatives. Investment A

Question

Firm L has $500,000 to invest and is considering two alternatives. Investment A would pay 6 percent ($30,000 annual before-tax cash flow). Investment B would pay 4.8 percent ($24,000 annual before-tax cash flow). The return on Investment A is taxable, while the return on Investment B is tax exempt. Firm L forecasts that its 21 percent marginal tax rate will be stable for the foreseeable future.

a. Compute the explicit tax and implicit tax that Firm L will pay with respect to Investment A and Investment B.

b-1. What is the annual after-tax cash flow for Investment A?

b-2. What is the annual after-tax cash flow for Investment B?

b-3. Which investment results in the greater annual after-tax cash flow?

Explanation / Answer

a. Explicit and Implicit Tax that Firm L will pay with respect to Investment A = $30000 * 21%

= 6300$

Explicit and Implicit Tax thar Firm L will pay with respect to Investment B = $ 24000 * 0

= 0

b.-1 Annual After Tax cash flow for Investment A = $30000 - $6300 = $23700

b-2 Annual after Tax cash flow for Investment B = $24000.

b-3 As we can see that after tax cash flow for Investment A is Rs $23700 and after tax cash flow for Investment B is $24000, we can say that investment B will result in greater annual after tax cash flow.

Related Questions

Navigate

• Browse (All)
• Browse F
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.