A corporation is choosing how much capital to utilize. Suppose the depreciation allowance has present value z=.6. The depreciation rate is =.10. The corporate tax rate is =.35. The financing cost of capital is =.15. The marginal revenue product of capital for the firm is 1000/K. Each unit of capital is worth $1.

a) What is the optimal choice of K?

b) What is the effective corporate tax rate?

c) Prior to 1986, corporations received an Investment Tax Credit for purchases of physical capital. This was an amount equal to =10% of the purchases. That is, for every $1 spent on capital in a year, the firm would have its taxes for the year reduced by $.10. This credit could be in addition to any depreciation allowance the firm might get for its capital. If this credit =.10 is offered, what is the optimal choice of K for the firm?

d) Why might a government be interested in such a policy of investment tax credits? Briefly explain. Even if you didn't get the answer to c, you should be able to qualitatively infer what this policy was intended to do.