5. A large internet trading company, Goobook, is considering its strategy in the light of new taxation laws being imposed in the UK. The Board of Directors has asked their advisors to identify the expected amount of tax payments that they could save by adopting alternative strategies. The advisors indicate that Goobook have just two strategies to choose from, S and T, and the tax savings it will enjoy will depend upon the strategy they select and the degree of aggressive tax legislation which would be applied in the UK over the next 5 years, as follows: Likely tax savings ( M) over the next 5 years Degree of aggression of tax legislation in the UK Medium High Low 150 0 Rio Tax saving strategy 0 (a) Outline how Goobook could develop a utility curve for the Board of Directors to help them make the decision of the best strategy to follow. [30 marks] Draw the possible shape of the Board of Director's utility curve if they were risk preferring for tax savings of less than 50M, risk neutral for tax savings of between 50M and 100M and risk averse for tax savings greater than 100M. [15 marks] Goobook estimate that the probability of a low, medium and high degree of aggression in the tax legislation is 0.4, 0.5 and 0.1. respectively. After extensive consultation with their advisors, Goobook come to the view that the Board's utility function is best defined as follows: Utility = (Likely tax savings over the next 5 years /150). [i.e. If tax savings over the next 5 years are 75, then Utility= 0.5] (c) Which tax saving strategy should Goobook adopt [30 marks] IVIRIVUUTTVV Explain to Goobook what prospect theory suggests is the likely shape of their probability weighting function and how this might influence the decision arrived at in (c). [25 marks] 5. A large internet trading company, Goobook, is considering its strategy in the light of new taxation laws being imposed in the UK. The Board of Directors has asked their advisors to identify the expected amount of tax payments that they could save by adopting alternative strategies. The advisors indicate that Goobook have just two strategies to choose from, S and T, and the tax savings it will enjoy will depend upon the strategy they select and the degree of aggressive tax legislation which would be applied in the UK over the next 5 years, as follows: Likely tax savings ( M) over the next 5 years Degree of aggression of tax legislation in the UK Medium High Low 150 0 Rio Tax saving strategy 0 (a) Outline how Goobook could develop a utility curve for the Board of Directors to help them make the decision of the best strategy to follow. [30 marks] Draw the possible shape of the Board of Director's utility curve if they were risk preferring for tax savings of less than 50M, risk neutral for tax savings of between 50M and 100M and risk averse for tax savings greater than 100M. [15 marks] Goobook estimate that the probability of a low, medium and high degree of aggression in the tax legislation is 0.4, 0.5 and 0.1. respectively. After extensive consultation with their advisors, Goobook come to the view that the Board's utility function is best defined as follows: Utility = (Likely tax savings over the next 5 years /150). [i.e. If tax savings over the next 5 years are 75, then Utility= 0.5] (c) Which tax saving strategy should Goobook adopt [30 marks] IVIRIVUUTTVV Explain to Goobook what prospect theory suggests is the likely shape of their probability weighting function and how this might influence the decision arrived at in (c). [25 marks]
