Question

Reese, 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. Reese can pay the $25,000 bill anytime before January 30 of next year without penalty. Assume Reese's marginal tax rate is 32 percent this year and will be 37 percent next year, and that she can earn an after-tax rate of return of 9 percent on her investments. a. What is the after-tax cost if she pays the $25,000 bill in December? After-tax cost b. What is the after-tax cost if she pays the $25,000 bill in January? Use Exhibit 3.1. (Round your answer to the nearest whole dollar amount.) After-tax cost c. Based on requirements a and b, should Reese pay the $25,000 bill in December or January?

Answer 1

Reese
a)
After-tax cost = Pretax Cost – Present Value Tax Savings
Pretax Cost	$   25,000.00
Present value tax savings = $25000 x 32% x PV(9%,0)	$     8,000.00
After tax cost	$   17,000.00
b)
After-tax cost = Pretax Cost – Present Value Tax Savings
Pretax Cost	$   25,000.00
Present value tax savings = $25000 x 37% x PV(9%,1)	$8,486.24
After tax cost	$        16,514
c) Paying the $25,000 in January is the clear winner.
part 2)
a)
After-tax cost = Pretax Cost – Present Value Tax Savings
Pretax Cost	$   51,000.00
Present value tax savings = $51000 x 32% x PV(10%,0)	$   16,320.00
After tax cost	$   34,680.00
b)
After-tax cost = Pretax Cost – Present Value Tax Savings
Pretax Cost	$   51,000.00
Present value tax savings = $51000 x 35% x PV(10%,1)	$16,227.27
After tax cost	$        34,773
c) Paying the $51,000 in December is the clear winner.
d)
After-tax cost = Pretax Cost – Present Value Tax Savings
Pretax Cost	$   51,000.00
Present value tax savings = $51000 x 24% x PV(10%,1)	$11,127.27
After tax cost	$        39,873
e) Paying the $51,000 in December is the clear winner.