Suppose that firms face a 40% income tax rate on all profits. In particular, losses receive full

credit. Firm A has a 50% probability of a $1,100 profit and a 50% probability of an $800 loss

each year. Firm B has a 50% probability of a $200 profit and a 50% probability of a $100 profit

each year. (Show all work or no credit will be given.)

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

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

c. If the firm can get full credit for tax losses, what can you conclude about the tax code's

impact on the tax benefits of hedging?