Test Bank Docx Chapter 3 Taxes as Transaction Costs

Principles of Taxation for Business and Investment Planning, 23e (Jones)

Chapter 3 Taxes as Transaction Costs

1) Net cash flow from a transaction equals the difference between cash received and cash disbursed in the transaction.

Difficulty: 1 Easy

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

2) The present value of a dollar available in a future period increases as the discount rate increases.

Explanation: Present value decreases as the discount rate increases.

Difficulty: 2 Medium

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

3) A dollar available today is always worth more than a dollar not available until a future period.

Difficulty: 1 Easy

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

4) A cash flow consisting of a constant dollar amount to be received for a specific number of future periods is called an annuity.

Difficulty: 1 Easy

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

5) An increase in the risk associated with a future stream of cash should result in an increase in the discount rate used in the present value calculation.

Difficulty: 2 Medium

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

6) The tax cost of a transaction represents a cash inflow.

Difficulty: 1 Easy

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

7) The tax savings from a transaction represents a cash inflow.

Difficulty: 1 Easy

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

8) Every business transaction results in a current tax cost or tax savings.

Explanation: Many business transactions have no current tax consequence and therefore do not result in a tax cost or tax savings.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

9) The tax cost of a transaction depends on the taxpayer's average tax rate for the year.

Explanation: The tax cost depends on the taxpayer's marginal tax rate.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

10) The tax cost of an income-generating transaction increases as the taxpayer's marginal tax rate increases.

Difficulty: 1 Easy

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

11) The tax savings from a deduction decreases as the taxpayer's marginal tax rate increases.

Difficulty: 1 Easy

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

12) A deduction is worth twice as much to a taxpayer with a 30% marginal rate than to a taxpayer with a 15% rate.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

13) The before-tax cash flow and after-tax cash flow from a nontaxable transaction are equal.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

14) A taxpayer's marginal tax rate and discount rate are independent variables in the NPV calculation.

Difficulty: 3 Hard

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

15) When the tax law applies differentially to transaction alternatives, decisions should focus on before-tax earnings.

Difficulty: 2 Medium

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

16) Tax law uncertainty is the risk that the Internal Revenue Service will challenge a taxpayer's tax treatment on audit.

Difficulty: 2 Medium

Topic: The Uncertainty of Tax Consequences

Learning Objective: 03-04 Identify the uncertainties concerning future tax costs and savings.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

17) Marginal rate uncertainty includes the risk that Congress will change tax rates, increasing the tax costs of future income.

Difficulty: 2 Medium

Topic: The Uncertainty of Tax Consequences

Learning Objective: 03-04 Identify the uncertainties concerning future tax costs and savings.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

18) A business strategy that reduces the tax cost of a transaction always increases the NPV of the transaction.

Explanation: If the strategy increases a nontax cost more than it reduces the tax cost, it will decrease the NPV.

Difficulty: 2 Medium

Topic: Structuring Transactions to Reduce Taxes

Learning Objective: 03-05 Explain why tax minimization may not be the optimal business strategy.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

19) Mr. Jessel sold 4,200 shares of stock in a publicly held corporation through his stock broker. This transaction occurred in a private market.

Difficulty: 1 Easy

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

20) Mr. and Mrs. Bing purchased a business from Ms. Clark in an arm's length transaction. This transaction occurred in a private market.

Difficulty: 1 Easy

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

21) Private market transactions create an opportunity for bilateral tax planning.

Difficulty: 1 Easy

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

22) Related party transactions occur in a public market.

Difficulty: 1 Easy

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

23) The IRS scrutinizes related party transactions more carefully than transactions occurring in a public market.

Difficulty: 2 Medium

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

24) The tax law prohibits related party transactions.

Difficulty: 1 Easy

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

25) The arm's length transaction presumption is unreliable for transactions between related parties.

Difficulty: 1 Easy

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

26) Use the present value tables included in Appendix A of your textbook to compute the NPV of $12,500 received in year 5 at a 6% discount rate.

A) $8,745.50

B) $9,337.50

C) $9,900.00

D) None of the above

Explanation: $12,500 × 0.747 discount factor for period 5.

Difficulty: 1 Easy

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

27) Use the present value tables included in Appendix A of your textbook to compute the NPV of $8,400 received in year 0, $4,950 received in year 1, and $3,000 received in year 2 at a 7% discount rate.

A) $14,018.00

B) $14,623.35

C) $15,647.25

D) None of the above

Explanation: $8,400 + ($4,950 × 0.935 discount factor for period 1) + ($3,000 × 0.873 discount factor for period 2).

Difficulty: 2 Medium

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

28) Use the present value tables included in Appendix B of your textbook to compute the NPV of four $25,000 payments received in years 0, 1, 2, and 3 at a 5% discount rate.

A) $93,075.00

B) $88,650.00

C) $81,445.50

D) None of the above

Explanation: $25,000 + ($25,000 × 2.723 discount factor for 3 periods).

Difficulty: 2 Medium

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

29) Which of the following statements about discount rates is true?

A) The higher the marginal tax rate, the higher the discount rate for future cash flows should be.

B) The higher the degree of risk involved in a transaction, the higher the discount rate for future cash flows should be.

C) The longer the time period over which a transaction will generate cash flows, the higher the discount rate should be.

D) The greater the amount of cash generated by a transaction, the higher the discount rate should be.

Explanation: The discount rate is independent of marginal tax rate, length of time period, or amount of cash.

Difficulty: 2 Medium

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

30) Which of the following statements about discount rates is false?

A) A discount rate for computing NPV cannot change from one period to the next.

B) The discount rate for a risky investment should be higher than the discount rate for a risk-free investment.

C) Discount rates can be applied either to the cash flow from a transaction or the taxable income from a transaction.

D) Both a discount rate for computing NPV cannot change from one period to the next and discount rates can be applied either to the cash flow from a transaction or the taxable income from a transaction.

Explanation: Discount rates are applied to cash flows.

Difficulty: 2 Medium

Topic: The Concept of Present Value

Learning Objective: 03-01 Compute a transaction's net present value (NPV).

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

31) BMX Company engaged in a current-year transaction that generated a $20,000 cash inflow. Which of the following statements is false?

A) If the cash inflow is not taxable income, the current-year tax cost of the transaction is zero.

B) If the cash inflow is taxable income and BMX's marginal tax rate is 25%, the tax cost of the transaction is $5,000.

C) If the cash inflow is taxable income and BMX's marginal tax rate is 35%, the tax cost of the transaction is $7,000.

D) None of the above is false.

Difficulty: 1 Easy

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

32) KRU Company engaged in a current-year transaction that required a $20,000 cash outflow. Which of the following statements is true?

A) If the cash outflow is deductible and BMX's marginal tax rate is 20%, the tax savings from the transaction is $4,000.

B) If the cash outflow is deductible and BMX's marginal tax rate is 30%, the tax savings from the transaction is $6,000.

C) If the cash outflow is not deductible, the current-year tax savings of the transaction is zero.

D) All of the above are true.

Difficulty: 1 Easy

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

33) Mr. Trail engaged in a current-year transaction generating $50,000 cash but only $40,000 taxable income. If Mr. Trail's marginal tax rate is 40%, compute his after-tax cash flow from the transaction.

A) $20,000

B) $24,000

C) $34,000

D) $40,000

Explanation: $50,000 before-tax-cash - $16,000 tax cost from $40,000 of  income.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

34) Ms. Lenz has $100,000 in an investment paying 9% annual interest. Her marginal tax rate is 25%. Which of the following statements is false?

A) Ms. Lenz's annual before-tax cash flow from this investment is $9,000.

B) If the interest is tax-exempt, Ms. Lenz's annual after-tax cash flow is $9,000.

C) If the interest is taxable, Ms. Lenz's annual after-tax cash flow is $6,750.

D) None of the above is false.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

35) Which of the following statements about marginal tax rates is true?

A) A taxpayer's marginal rate can change with every transaction.

B) As the marginal rate increases, the tax cost of an income-generating transaction decreases.

C) As the marginal rate increases, the tax savings from a deduction increases.

D) Both a taxpayer's marginal rate can change with every transaction and, as the marginal rate increases, the tax savings from a deduction increases.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

36) Which of the following statements about marginal tax rates is false?

A) A taxpayer's marginal rate does not change over time.

B) As the marginal rate decreases, the after-tax cost of a deductible expense increases.

C) As the marginal rate decreases, the after-tax value of an income-generating transaction increases.

D) Both a taxpayer's marginal rate does not change over time and, as the marginal rate decreases, the after-tax cost of a deductible expense increases.

Explanation: As the marginal rate decreases, the after-tax cost of a deductible expense increases.

Difficulty: 3 Hard

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

37) Omar Inc. paid a $24,000 expense, only $18,000 of which was deductible. If Omar's marginal tax rate is 40%, compute the after-tax cost of the expense.

A) $24,000

B) $18,000

C) $16,800

D) $10,800

Explanation: $24,000 before-tax cost − $7,200 tax computed as ($18,000 deduction × 40%).

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

38) Omar Inc. paid a $24,000 expense, of which only $10,000 was deductible. Which of the following statements is false?

A) If Omar's marginal tax rate is 10%, the after-tax cost of the expense is $9,000.

B) Regardless of Omar's marginal tax rate, the before-tax cost of the expense is $24,000.

C) If Omar's marginal tax rate is 30%, the after-tax cost of the expense is $21,000.

D) The after-tax cost of the expense depends on Omar's marginal tax rate.

Difficulty: 1 Easy

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

39) Ms. Teague incurred a $35,000 expense. If her marginal tax rate is 20%, which of the following statements is true?

A) If the expense is nondeductible, Ms. Teague's after-tax cost is zero.

B) If the expense is deductible, Ms. Teague's after-tax cost is $28,000.

C) If only $17,500 of the expense is deductible, Ms. Teague's after-tax cost is $14,000.

D) If the expense is nondeductible, Ms. Teague's after-tax cost is zero and, if the expense is deductible, Ms. Teague's after-tax cost is $28,000.

Explanation: Ms. Teague's before-tax cost is $35,000. If only $17,500 is deductible, her after-tax cost is $31,500 ($35,000 − $3,500 tax savings from the deduction). If the expense is nondeductible, the after-tax cost is $35,000.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

40) Mrs. Scott received a $12,000 cash payment. If her marginal tax rate is 40%, which of the following statements is true?

A) If only $9,200 of the payment is taxable income, her after-tax cash flow is $9,200.

B) If the payment is not taxable income, her after-tax cash flow is $12,000.

C) If the payment is taxable income, her after-tax cash flow is $4,800.

D) None of the above is true.

Difficulty: 1 Easy

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

41) Reid Inc. received a $90,000 cash payment, of which only $50,000 was taxable income. If Reid's marginal tax rate is 40%, compute Reid's after-tax cash flow.

A) $54,000

B) $50,000

C) $30,000

D) None of the above

Explanation: Reid's after-tax cash flow is $70,000 ($90,000 before-tax cash − $20,000 tax cost on $50,000 income).

Difficulty: 3 Hard

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

42) Ms. Kent has $200,000 in an investment paying 8% annual interest. Her marginal tax rate is 40%. Which of the following statements is false?

A) Ms. Kent's annual before-tax cash flow from this investment is $16,000.

B) If the interest is tax-exempt, Ms. Kent's annual after-tax cash flow is $16,000.

C) If the interest is taxable, Ms. Kent's annual after-tax cash flow is $6,400.

D) None of the above is false.

Explanation: If the interest is taxable, Ms. Kent's annual after-tax cash flow is $9,600 ($16,000 − $6,400 tax cost at 40%).

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

43) Leto Inc. has $500,000 in an investment paying 8% annual taxable interest. Each year, the corporation incurs a $3,000 nondeductible cash expense relating to the investment. If Leto's marginal tax rate is 35%, compute the annual after-tax cash flow.

A) $23,000

B) $24,050

C) $37,000

D) None of the above.

Explanation: Leto's annual tax cost is $14,000 ($40,000 annual interest × 35%), and its after-tax cash flow is $23,000 ($40,000 interest − $3,000 expense − $14,000 tax cost).

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

44) Ms. Leik has $50,000 in an investment paying 10% annual interest. Each year, she incurs a $600 cash expense relating to the investment. If Ms. Leik's marginal tax rate is 20%, which of the following statements is true?

A) Ms. Leik's annual after-tax cash flow from this investment is $3,520.

B) If the interest is taxable but the expense is not deductible, Ms. Leik's annual after-tax cash flow from the investment is $3,400.

C) If the interest is tax-exempt and the expense is not deductible, Ms. Leik's annual after-tax cash flow is $5,000.

D) None of the choices are true.

Explanation: If the $5,000 annual interest is taxable and the expense is not deductible, Ms. Leik's annual tax cost is $1,000 ($5,000 × 20%), and her after-tax cash flow is $3,400 ($5,000 interest − $600 expense − $1,000 tax cost).

Difficulty: 3 Hard

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

45) Holter Inc. owns an investment that generated $120,000 cash revenue and required $26,500 cash expenses this year. Holter's marginal tax rate is 30%. Which of the following statements is false?

A) Holter's before-tax cash flow is $93,500.

B) If the revenue is taxable, but only $19,000 of the expenses are deductible, Holter's after-tax cash flow is $63,200.

C) If only $105,000 of the revenue is taxable, but all the expenses are deductible, Holter's after-tax cash flow is $69,950.

D) None of the above is false.

Explanation: If the revenue is taxable, but only $19,000 of the expenses are deductible, Holter's after-tax cash flow is $63,200, Holter's taxable income is $101,000, its tax cost is $30,300, and its after-tax cash flow is $63,200 ($93,500 before-tax cash flow − $30,300 tax cost). If only $105,000 of the revenue is taxable, but all the expenses are deductible, Holter's after-tax cash flow is $69,950, Holter's taxable income is $78,500, its tax cost is $23,550, and its after-tax cash flow is $69,950 ($93,500 before-tax cash flow − $23,550 tax cost).

Difficulty: 3 Hard

Topic: The Concept of Present Value

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

46) Mr. and Mrs. Dean own an investment that generated $60,000 cash revenue and required $12,000 cash expenses this year. The Deans' marginal tax rate is 25%. Which of the following statements is true?

A) If only $52,000 of the revenue is taxable, but all the expenses are deductible, the Deans' after-tax cash flow is $40,000.

B) If the revenue is taxable, but only $8,500 of the expenses are deductible, the Deans' after-tax cash flow is $38,625.

C) The Deans' before-tax cash flow is $48,000.

D) Both if the revenue is taxable, but only $8,500 of the expenses are deductible, the Deans' after-tax cash flow is $38,625 and the Deans' before-tax cash flow is $48,000.

Explanation: If only $52,000 of the revenue is taxable, but all the expenses are deductible, the Deans' after-tax cash flow is $40,000, the Deans' taxable income is $40,000, their tax cost is $10,000, and their after-tax cash flow is $38,000 ($48,000 before-tax cash flow − $10,000 tax cost). If the revenue is taxable, but only $8,500 of the expenses are deductible, the Deans' after-tax cash flow is $38,625, the Deans' taxable income is $51,500, their tax cost is $12,875, and their after-tax cash flow is $35,125 ($48,000 before-tax cash flow − $12,875 tax cost).

Difficulty: 3 Hard

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

47) Rarke Company must choose between two alternate transactions. Transaction 1 requires a $20,000 nondeductible cash outlay, while transaction 2 requires a $25,000 deductible cash outlay. Determine the marginal tax rate at which the after-tax costs of the two transactions are equal.

A) 15%

B) 20%

C) 25%

D) 30%

Explanation: The tax savings from a $25,000 deduction at a 20% tax rate is $5,000, so the after-tax cost of the $25,000 cash outlay is $20,000.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

48) Unlow Inc. must choose between two alternate transactions. Transaction 1 would generate $160,000 cash, all of which would be taxable, while transaction 2 would generate $120,000 cash, none of which would be taxable. Determine the marginal tax rate at which the after-tax cash flows from the two transactions are equal.

A) 15%

B) 20%

C) 25%

D) 30%

Explanation: The tax on $160,000 income at a 25% tax rate is $40,000, so the after-tax cash flow would be $120,000.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

49) XYT Company engaged in a transaction that generated $50,000 cash deposited in the company bank account and required the company to pay $12,000 out of that account. XYT's marginal tax rate is 30%. Which of the following statements is false?

A) If the deposit is taxable income and the payment is deductible, the transaction generated $26,600 after-tax cash flow.

B) If the deposit is taxable income but the payment is nondeductible, the transaction generated $35,000 after-tax cash flow.

C) If the deposit is not taxable income and the payment is nondeductible, the transaction generated $38,000 after-tax cash flow.

D) None of the above is false.

Explanation: $38,000 before-tax cash flow − $15,000 tax ($50,000 × 30%) = $23,000 after-tax cash flow.

Difficulty: 2 Medium

Topic: Tax Costs

Learning Objective: 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

50) Mr. Quest plans to engage in a transaction that will generate $10,000 cash flow in year 0, year 1, and year 2 ($30,000 total cash flow). Which of the following statements is true?

A) If the cash flow is not taxable income, the before-tax and after-tax cash flows from the transaction are equal.

B) If the cash flow is not taxable income, the NPV of the transaction is $30,000.

C) Mr. Quest's discount rate for computing the NPV of the transaction depends on his marginal tax rate.

D) None of the above is true.

Difficulty: 1 Easy

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

51) Mr. Wills invested in a business that will generate $75,000 annual after-tax cash flow in years 0 and 1 and $90,000 annual after-tax cash flow in years 2 and 3. Compute the NPV of these cash flows at a 10% discount rate using Appendix A.

A) $259,185

B) $277,348

C) $290,310

D) None of the above

Explanation: The NPV is $285,105 ($75,000 + [$75,000 × 0.909] + [$90,000 × 0.826] + [$90,000 × 0.751]).

Difficulty: 2 Medium

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

52) Mr. and Mrs. Rath invested in a business that will generate the following cash flows over a three-year period. Use Appendix A. 

If the Raths' marginal tax rate over the three-year period is 20% and they use a 6% discount rate, compute the NPV of the transaction.

A) $59,340

B) $55,996

C) $50,413

D) None of the above.

Explanation:

NPV = $12,000 + $18,860 + $28,480 = $59,340.

Difficulty: 2 Medium

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

53) Ms. Card bought an investment that will generate the following cash flows over a three-year period. Use Appendix A. 

If Ms. Card's marginal tax rate over the three-year period is 40% and she uses a 6% discount rate, compute the NPV of the transaction (round the final answer to the nearest whole dollar).

A) $94,129

B) $84,964

C) $62,373

D) None of the above.

Explanation:

NPV = $19,200 + $28,384 + $37,380 = $84,964.

Difficulty: 3 Hard

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

54) Mr. Basel made an investment that will generate the following cash flows over a three-year period. Use Appendix A. 

If Mr. Basel's marginal tax rate over the three-year period is 20% and he uses a 6% discount rate, compute the NPV of the transaction (round the final answer to the nearest whole dollar).

A) $30,028

B) $33,557

C) $39,781

D) None of the above.

Explanation: The correct NPV is $32,868 ($7,600 + $10,939 + $14,329)

Difficulty: 3 Hard

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

55) Mrs. Biggs invested in a business that will generate the following cash flows over a three-year period. Use Appendix A.

If Mrs. Biggs' marginal tax rate over the three-year period is 30% and she uses a 6% discount rate, compute the NPV of the transaction.

A) $61,453

B) $52,771

C) $47,781

D) None of the above.

Explanation:

NPV = $9,500 + $16,031 + $22,250 = $47,781.

Difficulty: 3 Hard

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

56) Which of the following statements about different tax rates over time is false?

A) A 5% increase in the tax rate for year 10 has less effect on NPV than a 5% increase in the tax rate for year 4.

B) Future tax rates used in NPV calculations are estimates because Congress can change the statutory rates every year.

C) A NPV calculation must assume a constant tax rate for all future periods.

D) A firm's future tax rate may change because of increases or decreases in future taxable income.

Difficulty: 2 Medium

Topic: Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

57) If Congress enacts legislation late in the year that is retroactive to the beginning of the year, the legislation increases:

A) Audit risk

B) Tax law uncertainty

C) Financial risk

D) Marginal tax rate uncertainty

Difficulty: 1 Easy

Topic: The Uncertainty of Tax Consequences

Learning Objective: 03-04 Identify the uncertainties concerning future tax costs and savings.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

58) If Congress enacts a temporary change in the tax law that will apply for only two taxable years, the change increases:

A) Market risk

B) Financial risk

C) Audit risk

D) Tax law uncertainty

Difficulty: 1 Easy

Topic: The Uncertainty of Tax Consequences

Learning Objective: 03-04 Identify the uncertainties concerning future tax costs and savings.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

59) If a taxpayer decides to take advantage of an ambiguous tax issue to reduce future tax costs, the decision increases:

A) Financial risk

B) Audit risk

C) Tax law uncertainty

D) Marginal tax rate uncertainty

Difficulty: 1 Easy

Topic: The Uncertainty of Tax Consequences

Learning Objective: 03-04 Identify the uncertainties concerning future tax costs and savings.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

60) Hower Inc.'s tax advisor recommends that the corporation take a deduction that the IRS has disallowed for other corporations in similar circumstances. If Hower decides not to take the deduction, it is reducing:

A) Audit risk

B) Tax law uncertainty

C) Business risk

D) None of the above

Difficulty: 1 Easy

Topic: The Uncertainty of Tax Consequences

Learning Objective: 03-04 Identify the uncertainties concerning future tax costs and savings.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

61) Late in the current year, Jolsen Company signed a four-year contract with an advertising agency. Under the contract, Jolsen must pay $375,000 annually for the agency's services. After Jolsen signed the contract, Congress enacted legislation disallowing any deduction for advertising expense for future tax years. Jolsen underestimated the after-tax cost of the contract because of:

A) Marginal tax rate uncertainty

B) Financial risk

C) Audit risk

D) Tax law uncertainty

Difficulty: 2 Medium

Topic: The Uncertainty of Tax Consequences

Learning Objective: 03-04 Identify the uncertainties concerning future tax costs and savings.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

62) Zazu Company is considering modifying a transaction to reduce the current year tax cost by $50,000. Which of the following statements is false?

A) The modification will increase the NPV of the transaction by $50,000.

B) The modification may affect the transaction's before-tax cash flows.

C) The modification may reduce the tax cost but increase one or more nontax costs.

D) The modification may not be desirable even though it reduces the tax cost.

Explanation: If the modification affects any nontax cash flows from the transaction, the effect on NPV will be more or less than $50,000.

Difficulty: 2 Medium

Topic: Structuring Transactions to Reduce Taxes

Learning Objective: 03-05 Explain why tax minimization may not be the optimal business strategy.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

63) Which of the following statements about tax minimization is true?

A) Tax minimization always maximizes the NPV of a transaction.

B) Tax minimization should be the goal of business and financial planning.

C) Tax minimization with respect to a transaction may not be the optimal strategy.

D) Tax minimization has no effect on nontax cash flows.

Difficulty: 1 Easy

Topic: Structuring Transactions to Reduce Taxes

Learning Objective: 03-05 Explain why tax minimization may not be the optimal business strategy.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

64) Angela Jones is considering two investments. The first produces $5,000 of tax-exempt income. The second produces income that will be subject to tax at a rate of 15%. Which of the following statements is true regarding Angela's choice?

A) Angela should always choose the first investment because it minimizes her tax costs.

B) If the second investment generates $5,500 of before-tax income, Angela should choose the first investment.

C) If the second investment generates $6,500 of before-tax income, Angela should choose the second investment.

D) Both if the second investment generates $5,500 of before-tax income, Angela should choose the first investment and if the second investment generates $6,500 of before-tax income, Angela should choose the second investment are true.

Difficulty: 3 Hard

Topic: Structuring Transactions to Reduce Taxes

Learning Objective: 03-05 Explain why tax minimization may not be the optimal business strategy.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

65) Mr. Vail made an offer to purchase a business for sale by Mr. Craig. Mr. Vail and Mr. Craig had never met prior to their negotiation of the terms of the sale. The sale is an example of a/an:

A) Arm's length transaction

B) Private market transaction

C) Public market transaction

D) Both an arm's length transaction and a private market transaction are true.

Difficulty: 1 Easy

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

66) TallBoy Inc. is a local furniture manufacturer and Leley Company is a retail furniture store. The two companies have no owners in common. Leley recently negotiated to purchase $845,000 of furniture from TallBoy. This purchase is an example of a/an:

A) Related party transaction

B) Public market transaction

C) Arm's length transaction

D) None of the above

Difficulty: 1 Easy

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

67) Ms. Owen purchased 2,000 shares of General Electric common stock through her broker. This purchase is an example of a:

A) Public market transaction

B) Fictitious market transaction

C) Private market transaction

D) Related party transaction

Difficulty: 1 Easy

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

68) The transacting parties can engage in bilateral tax planning when a transaction occurs in a:

A) Public market

B) Private market

C) Secondary market

D) None of the above

Difficulty: 1 Easy

Topic: Structuring Transactions to Reduce Taxes

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

69) Arm's length business transactions can occur in:

A) Private markets

B) Public markets

C) Fictitious markets

D) Both private and public markets

Difficulty: 1 Easy

Topic: Structuring Transactions to Reduce Taxes; Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.; 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

70) The arm's length transaction presumption:

A) Assumes that each party is dealing in its own economic self-interest.

B) Cannot be satisfied in a private market transaction.

C) Requires direct negotiation between parties to ensure an arm's length price.

D) Applies to both related party and unrelated party transactions.

Difficulty: 2 Medium

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

71) Which of the following statement about private market transactions is false?

A) Both parties have flexibility in determining the legal and financial characteristics of the transaction.

B) The parties negotiate directly with each other.

C) The parties are dealing at arm's length.

D) The parties must engage in unilateral instead of bilateral tax planning.

Difficulty: 2 Medium

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

72) Which of the following statements about public market transactions is true?

A) The parties negotiate directly with each other.

B) The parties must engage in unilateral instead of bilateral tax planning.

C) The parties are not transacting at arm's length.

D) Both parties have flexibility in determining the legal and financial characteristics of the transaction.

Difficulty: 2 Medium

Topic: Private Market Transactions

Learning Objective: 03-06 Explain why bilateral tax planning is important in private market transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

73) Mrs. Scott loaned $100,000 to her daughter Evelyn, who agreed to pay her mother $3,000 annual interest on the debt. This loan is an example of a/an:

A) Prohibited transaction

B) Public market transaction

C) Related party transaction

D) Arm's length transaction

Difficulty: 1 Easy

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

74) Which of the following statements about related party transactions is false?

A) The transaction may lack the economic tension characteristic of a transaction between unrelated parties.

B) The transaction may reflect a fictitious market.

C) The parties to the transaction may have compatible financial objectives.

D) None of the above is false.

Difficulty: 1 Easy

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

75) When the IRS audits a tax return, it is most likely to scrutinize the tax consequences of a/an:

A) Related party transaction

B) Private market transaction

C) Public market transaction

D) Arm's length transaction

Difficulty: 1 Easy

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

76) Which of the following statements concerning related party transactions is false?

A) The federal tax law prohibits related party transactions.

B) Related parties enjoy significant flexibility in controlling the tax consequences of their transactions.

C) A related party transactions is more likely to be scrutinized relative to a public transaction to ensure it meets an arm's length standard.

D) The IRS always disallows any favorable tax consequences of related party transactions.

Difficulty: 2 Medium

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

77) Which of the following is not a related party transaction?

A) Acme Corporation leases office space to Norton Company. Mr. and Mrs. Norton own Norton Company and 65% of Acme Corporation's stock.

B) BBD Inc. licenses a patent from Nugo Inc., which owns 82% of BBD's outstanding stock.

C) Beth Teal pays $15,000 a year to her gardener, Ben. Beth is Ben's grandmother.

D) All the transactions are between related parties.

Difficulty: 1 Easy

Topic: Fictitious Markets: Related Party Transactions

Learning Objective: 03-07 Distinguish between arm's-length and related party transactions.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

78) Citran Company will earn $150,000 revenue as payment for a three-year consulting engagement. Compute the NPV of the revenue using Appendix A if Citran will received $35,000 cash immediately (year 0), $35,000 cash next year (year 1) and $80,000 cash the following year (year 2). Citran will report the revenue as taxable income in the year received. Its marginal tax rate is 30%, and it uses an 8% discount rate.

Difficulty: 2 Medium

Topic: The Concept of Present Value; Tax Costs

Learning Objective: 03-01 Compute a transaction's net present value (NPV).; 03-02 Compute the tax cost of an income item and the tax savings from a deduction.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual

79) Pepper Company, which has a 25% marginal tax rate, must choose between two alternative transactions. Transaction 1 requires a $20,400 cash outlay that is a deductible current expense. Transaction 2 requires a $15,000 cash outlay that is a nondeductible current expense. Which transaction has the lesser after-tax cost to Pepper?

Difficulty: 1 Easy

Topic: The Concept of Present Value; Tax Costs; Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-01 Compute a transaction's net present value (NPV).; 03-02 Compute the tax cost of an income item and the tax savings from a deduction.; 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual

80) Yawl Inc. must choose between two business opportunities: Opportunity 1 will generate $40,000 before-tax cash flow in years 0, 1, and 2, with a $7,000 annual tax cost. Opportunity 2 will also generate $40,000 before-tax cash flow in years 0, 1, and 2. However, the tax cost will be $15,000 in year 0, $2,500 in year 2, and $2,500 in year 3. Which opportunity should Yawl choose if it uses a 6% discount rate to compute NPV (round the calculations to the nearest whole dollar)?

Difficulty: 2 Medium

Topic: The Concept of Present Value; Tax Costs; Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-01 Compute a transaction's net present value (NPV).; 03-02 Compute the tax cost of an income item and the tax savings from a deduction.; 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual

81) Borden Company has the choice between two investments. Investment 1 will generate a $27,000 deductible loss this year (year 0), $15,000 taxable income in year 1, and $60,000 taxable income in year 2. Investment 2 will generate $16,000 taxable income in years 0, 1, and 2. Assume that income and loss reflect before-tax cash flow for Borden. Use Appendix A to determine which opportunity Borden should choose if it has a 35% marginal tax rate and uses a 7% discount rate to compute NPV (round the calculations to the nearest whole dollar)?

Difficulty: 3 Hard

Topic: The Concept of Present Value; Tax Costs; Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-01 Compute a transaction's net present value (NPV).; 03-02 Compute the tax cost of an income item and the tax savings from a deduction.; 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual

82) Wilson Company has $100,000 in an investment paying 6% per annum. Each year Wilson incurs $1,200 of expenses related to this investment. Compute Wilson's annual net cash flow from this investment assuming the following.

A. Wilson's marginal tax rate is 10% and the annual expense is not deductible.

B. Wilson's marginal tax rate is 35% and the annual expense is deductible.

C. Wilson's marginal tax rate is 25% and one-half of the annual expense is deductible.

A. After-tax cash flow is $4,200 = $6,000 − $1,200 − (10% × $6,000).

B. After-tax cash flow is $3,120 = $6,000 − $1,200 − (35% × ($6,000 − $1,200)).

C. After-tax cash flow is $3,450 = $6,000 − $1,200 − (25% × ($6,000 − (50% × $1,200))).

Difficulty: 3 Hard

Topic: The Concept of Present Value; Tax Costs; Different Tax Treatments Across Transactions; Different Tax Rates Over Time

Learning Objective: 03-01 Compute a transaction's net present value (NPV).; 03-02 Compute the tax cost of an income item and the tax savings from a deduction.; 03-03 Integrate tax costs and savings into NPV calculations.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual