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Suppose that firms face 40% income tax rate on positive profits and that net losses receive...

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Finance

  1. Suppose that firms face 40% income tax rate on positive profitsand that net losses receive no credit. (Thus, if profits arepositive, after-tax income is (1 – 0.4) * profit, while if there isa loss, after-tax income is the amount lost.) Firms A and B havethe same cash flow distribution as in problem 5 above. Suppose theappropriate effective annual discount rate for both firms is 10%?
    1. What is the expected pre-tax profit for A and B?
    2. What is the expected after-tax profit for A and B?
    3. What would Firms A and B pay today to receive next year’sexpected cash flow for sure, instead of the variable cash flowsdescribed above?

Here I attach problem 5, so you can see the info for problem 6,problem 6 is the one that I want to get the answer.

Problem 5.

  1. Suppose that firms face 40% income tax rate on all profits. Inparticular, losses receive full credit. Firm A has 50% probabilityof 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% probabilityof a $100 profit each year.

Answer & Explanation Solved by verified expert
4.4 Ratings (959 Votes)
GivenTax rate 40 or 040Discount rate 10    See Answer
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