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undefined 2. Suppose that two firms face a 35% income tax rate on positive profits. Firm 1 has the following cash flow distribution: 50% of
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2. Suppose that two firms face a 35% income tax rate on positive profits. Firm 1 has the following cash flow distribution: 50% of chance to get a $800 profit, or otherwise get $ 500 of loss; and firm 2 has 50% probability of a $300 profit and otherwise gets a $ 150 profit. Suppose the appropriate effective annual discount rate for both firms is 10%. (a) What is the expected pre-tax profit for the two firms? What is the expected after-tax profit for each of the firms, when the firms receive tax credit back in the presence of net losses? (6 points) 2 (b) What is the expected after-tax profit for each of the firms, when the firms do not receive tax credit on net losses? (6 points) (c) In the presence of tax on profit and no tax credit on losses, do some firms pre- fer the expected average amount for sure (rather than high and low values with uncertainty)? Why/why not? (describe in one sentence) (4 points) (d) Would any of the firms be willing to pay today to receive next year's expected cash flow for sure, instead of the variable cash flows described above? (7 points)Step by Step Solution
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