Question

Isabel, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December she received a $25,000 bill from her accountant for consulting services related to her small business. Isabel can pay the $25,000 bill anytime before January 30 of next year without penalty. Assume her marginal tax rate is 20 percent this year and next year, and that she can earn an after-tax rate of return of 6 percent on her Investments. a. What is the after-tax cost if Isabel pays the $25,000 bill in December? After-tax cost b. What is the after-tax cost if Isabel pays the $25,000 bill In January? Use Exhibit 3.1. After-tax cost c. Based on requirements a and b, should Isabel pay the $25,000 bill in December or January? December January

Answer 1

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Ans. a) Paesent value of Tax savings = Amount & marginal tax rate = $ 25000 x 20% - $500 tat After tax cart-= Pretax cast - Present value = $ 2500 - $500 = $ 20,000 . After-tax Cart if Isabel pays bill in December = $20,000 v bl Besent value Tax Sarings = $2500x20% = Sodo Discount factor: Present value Future value (It P.ign 140.06) = 0.943 Amount & Discount present value of Tax Sarings = factor $ S600 x 0.943 $ 4715 Pre tax cost - Present value After-tax Cost = if pand in January tax $ 2.5000 - $4715 = $20285 since bill is the paid after tax January cost is higher when the it is better to pay bill. in in December

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