Suppose that firms face 40% income tax rate on positive profits and that net losses receive no credit. (Thus, if profits are positive, after-tax income is (1 - 0.4) * profit, while if there is a loss, after-tax income is the amount lost.) Firms A and B have the same cash flow distribution as in problem 5 above. Suppose the appropriate effective annual discount rate for both firms is 10%?

a.What is the expected pre-tax profit for A and B?

b.What is the expected after-tax profit for A and B?

c.What would Firms A and B pay today to receive next year's expected cash flow for sure, instead of the variable cash flows described above?

***Here is problem number 5 so you can see the information you need from problem 5.

problem 5:

Suppose that firms face 40% income tax rate on all profits. In particular, losses receive full credit. Firm A has 50% probability of a $1000 profit and a 50% probability of a $600 loss each year. Firm B has a 50% probability is a $300 profit and a 50% probability of a $100 profit each year.