1) Problem # 9 (P. 885, Ch. 16.3) Some universities allow an employee to put an
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Question
1) Problem # 9 (P. 885, Ch. 16.3) Some universities allow an employee to put an amount q into an account at the beginning of each year, to be used for child-care expenses. The amount q is not subject to federal income tax. Assume that all other income is taxed by the federal government at a 40% rate. If child-care expenses for the year (call them d) are less than q, the employee in effect loses q - d dollars in before-tax income. If child-care expenses exceed q, the employee must pay the excess out of his or her own pocket but may credit 25% of that as a savings on his or her state income tax. Suppose Professor Muffy Rabbit believes that there is an equal chance that her child-care expenses for the coming year will be $3,000, $4,000, $5,000, $6,000, or $7,000. At the beginning of the year, how much money should she place in the child-care account?Explanation / Answer
Given: The chance that the child care expense for the year may be
#3000 is 25%
$4000 is 25%
$5000 is 25%
$6000 is 25%
loss occurs when q>d
when q<d then 25% of this can be claimed as savings at the end of the year.
She has to keep $4000 aside for child care because,
even if the day care costs $3000, q-d= 1000(of course a loss is incurred) and if it is exactly $4000 no loss at all, if $5000 then$250 can be claimed as savings(loss of @750) and if day care costs $6000, then she can claim $375(then loss of $925).
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