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Questions and Answers of Corporate Finance

Suppose that your neighbor is willing to pay you $ 100 to do some home repairs for her. You would be willing to do the job for $ 80, so you strike a deal. Now suppose that the government levies •
Responding to a congressional proposal to impose a 5 percent tax on elective cosmetic surgery, a spokesman for a company that pro-duces Botox said such a tax would result in “ a very marginal”
“In the formula for excess burden given in Equation ( 15.3) , the tax is less than 1. When it is squared, the result is smaller, not bigger. Thus, having t 2 instead of t in the formula makes the
In 2012, the Obama administration proposed a set of policies that would increase the top income tax rate from 35 percent to approximately 44 percent. By what proportion would this increase the excess
In 2006, several members of Congress argued for eliminating most of the tax reductions that had been enacted during the previous five years. However, virtually no one was in favor of eliminating the
Former Secretary of Labor Robert Reich has advocated for a cap- and- trade program for greenhouse gases. Under Reich’s proposal, the government would auction off the permits and distribute the
In 2012, the Nigerian government removed a subsidy on fuel. One critic of the removal of the subsidy argued that the government was unable to clearly articulate how this would benefit Nigerians,
In the United Kingdom, each household that owns a television pays a compulsory levy that is equivalent to $ 233 per year. The total revenue collected, which is over $ 7 billion annually, goes to the
During the 2012 Republican presidential primary campaign, Senator Rick Santorum proposed cutting the corporate tax rate from 35 percent to zero for manufacturers but only to 17.5 percent for other
Under the US tax system, capital that is employed in the corporate sector is taxed at a higher rate than capital in the noncorporate sector. This problem will analyze the excess burden of the
In an effort to reduce alcohol consumption, the government is considering a $ 1 tax on each gallon of liquor sold (the tax is levied on producers). Suppose that the supply curve for liquor is upward
According to estimates by Goolsbee and Petrin [2004], the elasticity of demand for basic cable service is 0.51, and the elasticity of demand for direct broadcast satellites is 7.40. Suppose that a
In 2002, the US federal government levied a tax of 3 percent on that part of a car’s price exceeding $ 40,000. [For example, the tax liability on a $ 50,000 car would be 0.03 ($ 50,000 $ 40,000),
“Peter the Great at one time levied a tax upon beards. He held that the beard was a superfluous and useless ornament. The tax is said to have been proportional according to the length of the beard
In 2008, the sales tax in Cook County, Illinois, was doubled. One journalist speculated that the tax increase was enacted because government officials sensed that the tax base was more captive than
Suppose that a town is considering a project to install new underground water pipes. Some of the costs are fixed in the sense that they do not increase with an increase in the amount of water
In 2008, New York State increased its tax on cigarettes by $ 1.25 per pack. One commentator noted that “ most cigarettes sold [ in New York] will actually be trucked up from Virginia or shipped
The government provides patents to pharmaceutical companies that allow them to charge high prices for the drugs they develop for some years. If a company succeeds in developing an effective drug, the
Indicate whether each of the following statements is true, false, or uncertain, and explain why: a. A proportional tax on all commodities including leisure is equivalent to a lump sum tax. b.
In 1968, the Supreme Court ruled that citizens can sue to stop the government from spending that violates the Constitution. In a recent 5– 4 decision, the Court ruled that a tax credit that can be
Under current law, if your capital losses exceed your capital gains, you can deduct as much as $ 3,000 of losses against other forms of income. In the wake of massive declines in the stock market, in
The New York Times published an article about a man who claimed that his tax rate was 102 per-cent of his income [Stewart, 2012]. He computed this figure by taking the ratio of his tax payments to
Singh, who has a federal personal income tax rate of 28 percent, holds an oil stock that appreciates in value by 10 percent each year. He bought the stock one year ago. Singh’s stock-broker now
Li’s marginal tax rate is 35 percent, and he itemizes his tax deductions. How much is a $ 500 deduction worth to him? How much is a $ 500 tax credit worth to him?
Suppose that a typical taxpayer has a marginal personal income tax rate of 35 percent. The nominal interest rate is 13 percent, and the expected inflation rate is 8 percent. a. What is the real
Athletes who win Olympic gold medals also receive a cash award of $ 25,000. In 2012, President Obama supported legislation proposed by Senator Marco Rubio to exempt these winnings from federal
In 2012, Republican presidential candidate Mitt Romney proposed a decrease in the tax rates on dividends and capital gains for most taxpayers. Would these changes make sense in terms of the Haig-
In 1968, the Supreme Court ruled that citizens can sue to stop the government from spending that violates the Constitution. In a recent 5– 4 decision, the Court ruled that a tax credit that can be
California law requires registered domestic partners to treat their earnings as common property for state tax purposes. Because federal tax law generally respects state property law, the Internal
You will need a calculator for this problem. Sanchez earns $ 4,000, and she wants to save it for retirement, which is 10 years away. She can either save it in a taxable account or put it into a Roth
Most economists believe that a reduction in all statutory federal income tax rates in the United States would be unlikely to generate an increase in tax revenues. However, a recent study suggests
Suppose that individuals view their loss of income from income taxes as offset by the benefits of public services purchased with the revenues. How are their labor supply decisions affected?
Under current law, employer provided health care benefits are excluded from taxation. Use an indifference curve analysis to model the impact of eliminating the exclusion upon the amount of health
According to one econometric study, “Denmark and Sweden are on the wrong side of the Laffer curve for capital income taxation” [Trabandt and Uhlig, 2009]. Explain what the words “wrong side”
According to Feldstein [2008b], “only about 10% to 20%” of a one-time tax rebate provided to taxpayers in 2008 was spent immediately. Using the life cycle model of Figure 18.7, explain why this
The top marginal tax rate was lowered from 90 percent to 70 percent in 1964. Following this change, the number of annual championship boxing matches increased substantially [Fetter, 2010]. Explain
In the face of reduced interest rates, one financial columnist gave the following advice: “To compensate for such modest returns, aim to save even more every month” [Clements, 2003]. Use the life
One of your authors received the following message in an e mail from a student: “ An individual who owns the house he lives in forgoes receiving rent from a tenant. This forgone rent represents an
Define the “after tax share” as 1 minus the marginal tax rate. Heim [2009] recently estimated the elasticity of taxable income with respect to the after tax share is 1.2 for people with incomes
In an economy, the supply curve of labor, S , is given byS = 100 + 200wnwhere w n is the after tax wage rate. Assume that the before tax wage rate is fixed at 10.a. Write a formula for tax revenues
During the 2012 presidential campaign, Mitt Romney argued that even though he paid only about 14 percent in taxes on his investment income, his total tax burden was much higher because the income is
Under US law, depreciation allowances are based on the original cost of acquiring the asset. No account is taken for the effects of inflation on the price level over time. a. How does inflation
Clausing [2007] found that corporate tax revenues rise and then fall with increases in the corporate tax rate. She also found that “smaller, more open economies have lower revenue-maximizing tax
Several years ago, RJR Nabisco incurred $ 2 million in costs for package design— the physical construction of a package and its graphic design. Nabisco wanted to deduct the entire $ 2 million in
During the 2012 presidential campaign, President Barack Obama proposed lowering the corporate tax rate from 35 percent to 28 percent. Evaluate the effect of this proposal on efficiency, equity, and
A letter to the editor of the Wall Street Journal made the following claim: “The tax code’s most regressive and unfair individual tax is— guess what?— the corporate income tax! All products
When a dairy farmer buys a cow, he is allowed to deduct 50 percent of its price in the first year as a form of accelerated depreciation. How would you determine the appropriate depreciation schedule
A law passed in 2009 allowed homebuilders to offset their losses incurred in the weak housing markets of 2008 and 2009 against profits the companies booked as far back as 2004 (when the housing
The ABC corporation is contemplating purchasing a new computer system that would yield a before- tax return of 30 percent. The system would depreciate at a rate of 1 percent a year. The after-tax
In 2012, the government of French President Francois Hollande raised both personal and corporate tax rates. Hollande’s prime minister “insisted that the burden would fall mainly on
How would each of the following events affect the national debt as it is currently measured? a. The government borrows to finance a Memorial Day parade. b. The Statue of Liberty is sold to a group
In 2010, the Greek government considered selling its stakes in a bank, a betting company, and a telecommunications company to reduce its budget deficit. Do you think this is a sensible approach to
According to Schick [ 2002, p. 46], “ The arrival of a surplus [ in the late 1990s] triggered a spending frenzy that vitiated the discretionary spending caps established by the 1990 Budget
Critics of unfunded government liabilities, such as those stemming from Social Security and Medicare, have characterized the policies as “fiscal child abuse.” Under what conditions do these
A reporter in 2012 paraphrased the view of Nobel Laureate Paul Krugman saying, “ In order to avoid a full- on depression, the U. S. government needs to ignore the size of the deficit and start
New York Times columnist David Brooks wrote that “In the private sphere, . . . , seniors provide wonderful gifts to their grandchildren, loving attention that will linger in young minds, providing
Zach lives two periods. He earns $ 10,000 in the first period and nothing in the second period. The rate of return is 10 percent, and there is an income tax (applied to labor and interest earnings)
According to a New York Times columnist, “The estate tax affects a surprisingly small number of people. In 2003, . . . just 1.25 percent of all deaths resulted in taxable estates, with most of them
In 2011, Derek Jeter hit a home run to become the twenty- eighth man to exceed 3,000 hits. This presented an interesting set of tax questions for the fan who caught the ball. In each case below, what
In January 2003, the late Professor David Bradford told a New York Times reporter that a consumption tax discourages work effort. Shortly thereafter, he received the following e- mail: “Since when
Ramesh lives two periods. His earnings in the present are 100; in the future they are 75.6. The interest rate is 8 percent. a. Suppose that Ramesh’s earnings are subject to a 25 percent tax.
Li- Na and Shirley both live two periods. Both have earnings of 1,000 in the present and zero in the future. The interest rate is 8 percent. Suppose that they are each subject to an income tax, and
Suppose that Aviva can earn supplemental in-come by working overtime. She intends to use any income she earns to buy shares of stock in a corporation, with the intention of leaving the shares to her
Both state and federal governments have regulations with respect to the amount of information that pharmaceutical companies have to provide about the health risks of their products. A case brought
Are you dissatisfied with your government? Then you might be interested in the notion of “seasteading.” The idea is to use refitted oil rigs to create permanent dwelling places at sea. The
In California, property values are reassessed only after a sale has taken place. For proper-ties that have not been sold in the past year, the law allows only a small increase in the assessed value.
Illustrate the following circumstances using community indifference curves and the local government budget constraint:a. An unconditional grant increases both the quantity of public goods purchased
In Switzerland, the cantons (states) offer low tax rates “ to tempt multinationals to establish regional headquarters or other operations in their jurisdictions. In doing so, other states are
Assume that the towns of Belmont and Lexington have different demand curves for firefighters and can hire firefighters at the same constant marginal cost. Suppose that historically their state
Heal [ 2001, p. 1] notes that when Frederick Law Olmsted, the designer of New York City’s Central Park, was asked how the city could pay for the park, “ he responded that its presence would raise
The federal government subsidizes state spending on welfare, thus changing the effective price to states of welfare spending. According states of welfare spending. According to Baicker [2005], the
List and briefly explain the first two steps of the capital budgeting process.
What is a company’s cost of capital and what role does it play in the capital budgeting process?
What is the return on investment and how is it related to the cost of capital?
Describe the four steps used in the net present value method.
Identify and explain the three key assumptions underlying net present value analysis.
Russell Corporation’s capital structure consists of $ 5,000,000 of assets and $ 2,000,000 of liabilities. Joe Russell, the corporation’s CEO and largest shareholder, says that the debt has an
If the average interest rate on debt is 11 percent, what is the cost of capital? Refer to E12.1. Russell Corporation’s capital structure consists of $ 5,000,000 of assets and $ 2,000,000 of
Gerard, a not- for- profit entity, is considering the acquisition of a baseball winder that costs $ 56,200. The baseball winder has an expected life of 10 years and is expected to reduce production
The United Way is considering purchasing a new machine with a cost of $ 9,000, no salvage value, and a useful life of five years. The machine is expected to generate $ 2,850 in cash inflows during
Murdock Company, a not-for-profit enterprise, is contemplating the acquisition of a new copier on December 30, 2009. The copier costs $ 42,600, has an estimated life of six years, and is expected to
Clerihew Kennels, a no-kill, not-for-profit, animal shelter, is considering replacing its manual accounting system with a computerized accounting system. As of January 1, 2011, the software package
As of January 1, 2011, Alvarado Company wants to acquire a new machine costing $ 196,000. The machine has an estimated useful life of seven years and no salvage value. Alvaradoâ€™s tax rate is
In 2011 the Tricola Company is considering whether to replace its old deicer with a more efficient deicer that costs $ 100,000. The old deicer has a book value of $ 16,000 and can be sold for $
The following cash savings are expected to occur if the city of Manhattan, Kansas, buys new trash trucks that cost $ 190,000 at the start of 2011. The city of Manhattan pays no taxes and uses a
O’Dell Enterprises manufactures lenses for telescopes. O’Dell is considering replacing a machine that grinds lenses and has received a proposal from a vendor for the new lens grinder. O’Dell
In January 2012, Herdt Company is trying to decide whether to buy one, both, or neither of the following investments. Herdt Companyâ€™s cost of capital is 16 percent and its tax rate is 30
Adams Products, Inc., manufactures a product it sells for $ 25. Adams sells all of the 24,000 units per year it is capable of producing at the current time, and a marketing study indicates that it
As of January 2, 2012, you have just completed a discounted cash flow analysis on a $ 250,000 invest-ment. You calculated after- tax cash flows ( including the following tax shield). You then
Mercil Corporation is going to buy one of the following two machines. Each machine meets the specifications for a particular task in the company. Mercil’s tax rate is 30 percent and its cost of
The Snethen Corporation has the opportunity to manufacture a new chemical but will have to buy a new machine that costs $ 350,000 to produce the chemical. The net present value of the new ma-chine is
Achord Company wants to determine whether it should invest in a piece of equipment that costs $ 1.5 million and is expected to last 10 years. At the end of the 10- year period, the equipment will be
Terry, Inc., wants to buy a new printing press. The cost of the press is $ 300,000, it is expected to last for 10 years after which it will be scrapped with no salvage value, and it will be
Distinguish between the market rate of interest and the face rate of interest on a note.
Describe the cash inflows and outflows of a lump-sum payment (noninterest-bearing) note shown on the budgeted statement of cash flows.
Describe the cash inflows and outflows of a periodic and lump-sum payment note shown on the budgeted statement of cash flows.
Describe the interest expense reflected on the budgeted income statement over the life of a periodic and lump-sum payment note.
Describe the carrying value shown on the budgeted balance sheet over the life of a periodic and lump-sum payment note.
What is the difference between an operating and a capital lease?
On April 1, Bailey Products borrowed $ 150,000 at 7 percent on a five-year installment loan. Annual payments are $ 36,583.60. How much of the first payment is principal and how much is interest? How

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