Question

Isabel, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December she received a $90,000 bill from her accountant for consulting services related to her small business. Isabel can pay the $90,000 bill anytime before January 30 of next year without penalty. Assume her marginal tax rate is 37 percent this year and next year, and that she can earn an after-tax rate of return of 8 percent on her investments.

a. What is the after-tax cost if Isabel pays the $90,000 bill in December?

b. What is the after-tax cost if Isabel pays the $90,000 bill in January? Use Exhibit 3.1. (Round your answer to the nearest whole dollar amount.)

c. Based on requirements a and b, should Isabel pay the $90,000 bill in December or January?

    

• December

• January

Answer 1

(a) -- What is the after-tax cost if Isabel pays the $90000 bill in December?

Answer -

	Explanation	Amount ($)
After-tax cost	Pretax cost - Present value tax savings = $90000 - ($90000 * 37%)	56700

.

(b) -- What is the after-tax cost if Isabel pays the $90000 bill in January?

Answer -

	Explanation	Amount ($)
After-tax cost	Pretax cost - Present value tax savings = $90000 - [($90000 * 37%) * PVIF of $1(i%, n)] = $90000 - [$33300 * $1(8%,1 year)] = $90000 - [$33300 * 0.926] = $90000 - $30836 = $59164	59164

.

(c) -- Based on requirements a and b, should Isabel pay the $90000 bill in December or January?

Answer -

Isabel should pay the $90000 bill in December, because in this month after-tax cost is less.