ACC 2460 – Fall 2003
Solutions to Suggested Homework Problems for Chapters 2 and 3
Chapter 2
Questions and Problems for Discussion
15. Jurisdiction Q could enact:
A gross receipts tax . Because Corporation R and Corporation T both have $5 million gross receipts, they would pay the same tax. Corporation T could argue that this result is horizontally inequitable because its gross and net profit are less than Corporation R’s gross and net profit, indicating that Corporation T has less ability to pay a tax.
A tax based on gross profit.
Because Corporation R has more gross profit than
Corporation T, Corporation R would pay the greater tax. Corporation R could argue that this result is horizontally inequitable because it has a higher ratio of annual operating expenses to gross profit (55.5 percent) than Corporation T (30.1 percent).
Consequently, gross profit doesn’t accurately reflect the two corporations’ ability to pay tax.
A tax based on net profit before charitable contributions . In this case, Cor poration R’s tax base would be $800,000 and Corporation T’s tax base would be $930,000.
Corporation T might argue that its generous charitable contributions reduced its economic ability to pay and should be taken into account. Corporation R could refute by arguing that discretionary charitable contributions are irrelevant to the measurement of a firm’s ability to pay tax on business earnings.
A tax based on net profit after charitable contributions . In this case, Corporation R would pay more tax than Corporation T and could argue that allowing Corporation T to deduct charitable contributions violates the concept of horizontal equity.
17. Ms. P should consider her marginal rate: the rate at which the incremental income from the investment will be taxed. For tax planning purposes, the average tax rate that Ms. P pays on her entire income is irrelevant.
Application Problems
2. a. $100,000 tax base (Mr. and Mrs. J’s taxable income) 
10% rate increase = $10,000 additional tax collected from Mr. and Mrs. J. b. $118,000 increased tax base

40%
Tax collected on original $100,000 base

30%
Additional tax collected from Mr. and Mrs. J
$47,200
(30,000)
$17,200 c. $90,000 decreased tax base

40%
Tax collected on original $100,000 base

30%
Additional tax collected from Mr. and Mrs. J
3. a. Taxpayer A’s liability on $83,000 of income is computed as follows:
6% of first $30,000 of income
10% of next $40,000 of income
20% of next $13,000 of income
$36,000
(30,000)
$ 6,000
$1,800
4,000
2,600
$8,400

3. a. b.
Taxpayer A’s average tax rate is 10.12 percent ($8,400 
$83,000) and his marginal tax rate is 20 percent. b. Taxpayer B’s liability on $310,000 of income is computed as follows:
6% of first $30,000 of income
10% of next $40,000 of income
20% of next $130,000 of income
28% of next $110,000 of income
$ 1,800
4,000
26,000
30,800
$62,600
Taxpayer B’s average tax rate is 20.19 percent ($62,600 
$310,000) and his marginal tax rate is 28 percent.
5. a. Individual C’s excise tax is $15 and C’s average tax rate is 3% ($15 ÷ $500). b. Individual D’s excise tax is $70 and D’s average tax rate is 1.4% ($70 ÷ $5,000). c. Jurisdiction Z’s excise tax meets a strict definition of vertical equity because individual D, who has a larger tax base than individual C, pays more tax than individual C. However, the tax is regressive because individual D’s average tax rate is less than individual C’s average tax rate.
Chapter 3
Application Problems c.
Income from investment
Deduction for expense
Taxable income
Marginal tax rate
Tax
Cash from investment
Expense
Tax cost
Net cash flow
Income from investment
Deduction for expense
Taxable income
Marginal tax rate
Tax
Expense
Tax cost
Net cash flow
Taxable income from investment
Marginal tax rate
Tax
Cash from investment
$12,000
(1,500)
$10,500
.15
$ 1,575
$12,000
(1,500)
(1,575)
$ 8,925
$12,000
(1,500)
$10,500
.35
$ 3,675
$12,000
(1,500)
(3,675)
$ 6,825
$12,000
.20
$ 2,400

5. d.
Cash from investment
Expense
Tax cost
Net cash flow
Income from investment
Deduction for expense
Taxable income
Marginal tax rate
Tax
Cash from investment
Expense
Tax cost
Net cash flow
Taxable income
Marginal tax rate
Tax
Revenue received
Expenses
Tax cost
Net cash flow
Discount factor (10%)
Present value
Net present value
12. a. Opportunity 1:
Year 0
$ 6,600
.35
$ 2,310
$10,000
(4,200)
(2,310)
$ 3,490
$ 3,490
$12,827
Taxable income (loss)
Marginal tax rate
Tax
Before-tax cash flow
Tax (cost) or savings
Net cash flow
Discount factor (12%)
Present value
NPV
Year 0
$(8,000)
.40
$(3,200)
$(8,000)
3,200
$(4,800)
$(4,800)
$7,443
$ 7,500
.35
$ 2,625
$12,500
(6,100)
(2,625)
$ 3,775
.909
$ 3,431
$12,000
(1,500)
(2,400)
$ 8,100
$12,000
(1,000)
$11,000
.35
$ 3,850
$12,000
(1,500)
(3,850)
$ 6,650
Year 1
Year 1
$5,000
.40
$2,000
$5,000
(2,000)
$3,000
.893
$2,679
Year 2
$11,000
.35
$ 3,850
$18,000
(7,000)
(3,850)
$ 7,150
.826
$ 5,906
Year 2
$20,000
.40
$8,000
$20,000
(8,000)
$12,000
.797
$9,564

Opportunity 2:
Taxable income
Marginal tax rate
Tax
Before-tax cash flow
Tax (cost) or savings
Net cash flow
Discount factor (12%)
Present value
NPV
M&B should choose opportunity 2. b. Opportunity 1:
Taxable income (loss)
Marginal tax rate
Tax
Before-tax cash flow
Tax (cost) or savings
Net cash flow
Discount factor (12%)
Present value
NPV
Opportunity 2:
Taxable income
Marginal tax rate
Tax
Before-tax cash flow
Tax (cost) or savings
Net cash flow
Discount factor (12%)
Present value
NPV
M&B should choose opportunity 2.
Year 0
$(8,000)
.15
$(1,200)
$(8,000)
1,200
$(6,800)
$(6,800)
$10,544
Year 0
$5,000
.15
$750
$5,000
(750)
$4,250
$4,250
$11,432
Year 0
$5,000
.40
$2,000
$5,000
(2,000)
$3,000
$3,000
$8,120
Year 1
$5,000
.40
$2,000
$5,000
(2,000)
$3,000
.893
$2,679
Year 1
$5,000
.15
$750
$5,000
(750)
$4,250
.893
$3,795
Year 1
$5,000
.15
$750
$5,000
(750)
$4,250
.893
$3,795
Year 2
Year 2
$5,000
.15
$750
$5,000
(750)
$4,250
.797
$3,387
$5,000
.40
$2,000
$5,000
(2,000)
$3,000
.797
$2,391
Year 2
$20,000
.15
$3,000
$20,000
(3,000)
$17,000
.797
$13,549

c. Opportunity 1:
Taxable income (loss)
Marginal tax rate
Tax
Before-tax cash flow
Tax (cost) or savings
Net cash flow
Discount factor (12%)
Present value
NPV
Opportunity 2:
Taxable income
Marginal tax rate
Tax
Before-tax cash flow
Tax (cost) or savings
Net cash flow
Discount factor (12%)
Present value
NPV
M&B should choose opportunity 1.
Tax Planning Cases
1. a. (1)
Before-tax salary/income
Marginal tax rate
Tax on income
After-tax cash flow
Discount factor (8%)
Present value
Net present value of salary received by Mrs. X
(2) Before-tax payment /deduction
Marginal tax rate
Tax savings from deduction
After-tax cost
Discount factor (8%)
Present value
Net present value of salary cost to Firm B
Year 0
$(8,000)
.40
$(3,200)
$(8,000)
3,200
$(4,800)
$(4,800)
$12,544
Year 0
$5,000
.40
$2,000
$5,000
(2,000)
$3,000
$3,000
$10,182
Year 0
$80,000
.25
$20,000
$60,000
$60,000
$145,584
$ 80,000
.34
$ 27,200
$(52,800) $(52,800)
.926
$(52,800) $(48,893)
$(146,943)
Year 1
$5,000
.15
$750
$5,000
(750)
$4,250
.893
$3,795
Year 1
$5,000
.15
$750
$5,000
(750)
$4,250
.893
$3,795
Year 1
$80,000
.40
$32,000
$48,000
.926
$44,448
$80,000
.34
$27,200
Year 2
Year 2
Year 2
$80,000
.40
$32,000
$48,000
.857
$41,136
$5,000
.15
$750
$5,000
(750)
$4,250
.797
$3,387
$20,000
.15
$3,000
$20,000
(3,000)
$17,000
.797
$13,549
$80,000
.34
$27,200
$(52,800)
.857
$(45,250)

b. (1)
Before-tax salary/income
Marginal tax rate
Tax on income
After-tax cash flow
Discount factor (8%)
Present value
Net present value of salary received by Mrs. X
Year 0
$140,000
.25
$ 35,000
$105,000
$105,000
Year 1
$50,000
.40
$20,000
$30,000
.926
$27,780
Year 2
$50,000
.40
$20,000
$30,000
.857
$25,710 c. d.
(2) Before-tax payment /deduction
Marginal tax rate
Tax savings from deduction
After-tax cost
Discount factor (8%)
Present value
Net present value of salary cost to Firm B
Before-tax payment /deduction
Marginal tax rate
Tax savings from deduction
After-tax cost
Discount factor (8%)
Present value
Before-tax salary/income
Marginal tax rate
Tax on income
After-tax cash flow
Discount factor (8%)
Present value
Net present value of salary received by Mrs. X
$158,490
$140,000
.34
$ 47,600
$(151,239)
$140,000
.34
$ 47,600
$(92,400)
$(92,400) $(27,502)
$140,000
.25
$ 35,000
$105,000
$105,000
$50,000
.34
$17,000
$(92,400) $(33,000)
.926
$(92,400) $(30,558)
$45,000
.34
$15,300
$(29,700)
.926
$45,000
.40
$18,000
$27,000
.926
$25,002
$50,000
.34
$17,000
$(33,000)
.857
$(28,281)
$45,000
.34
$15,300
$(29,700)
.857
$(25,423)
Net present value of salary cost to Firm B $(145,325)
This proposal is superior (has less cost) to Firm B than its original offer.
Year 0 Year 1 Year 2
$45,000
.40
$18,000
$27,000
.857
$23,139
$153,141
Mrs. X should accept this counterproposal because it has a greater net present value than Firm B’s original offer.