Problems 389a state taxable income of $150,000, what is the to-
tal state and f~deral income tax it must pay? Also,
compute its combined incremental state and federal
income tax rate. (Answers:$50,534; 43.93%)
12-12 An unmarried individual in California with a taxable
income of about $80,000 has a federal incremental
tax rate of 30% and a state incremental tax rate of
9.3%. What is his combined incremental tax rate?
12-13 The Lynch Bull investment company suggests that
Steven Comstock, a wealthy New York City investor
(his incremental income tax rate is 38.6%), consider
the following investment.
Buy corporate bonds on the New York Stock Ex-
change with a face value (par value) of $100,000 and
a 5% coupon rate (the bonds pay 5% of $100,000,
which equals $5000 interest per year). These bonds
can be purchased at their present market value of
$75,000. At the end of each year, Steve will receive
the $5000 interest, and at the end of 5 years, when the
bonds mature, he will receive $100,000 plus the last
$5000 of interest.
Steve will pay for the bonds by borrowing
$50,000 at 10% interest for 5 years. The $5000 inter-
est paid on the loan each year will equal the $5000 of
interest income from the bonds. As a result Steve will
have no net taxable income during the five years due
to this bond purchase and borrowing money scheme.
At the end of 5 years, Steve will receive $100,000
plus $5000 interest from the bonds and will repay the
$50,000 loan and pay the last $5000 interest. The
net result is that he will have a $25,000 capital gain;
that is, he will receive $100,000 from a $75,000 in-
vestment.(Note:This situation represents an actual
recommendation of a brokerage firm.)
(a)Compute Steve's after-tax rate of return on this
dual bond-plus-loan investment package.
(b)What would be Steve's after-tax rate ofreturn if
he purchased the bonds for $75,000 cash anddid
notborrow the $50,000?12-14 Albert Chan decided to buy an old duplex as an in-
vestment. After looking for several months, he found
a desirable duplex that could be bought for $93,000
cash. He decided that he would rent both sides of the
duplex, and determined that the total expected income
would be $800 per month. The total annual expenses
for property taxes, repairs, gardening, and so forth are
estimated at $600 per year. For tax purposes, Al plans
to depreciate the building by the sum-of-years' -digits
method, assuming that the building has a 20-year
remaining life and no salvage value. Of the total
$93,000 cost of the property, $84,000 represents the
value of the building and $9000 is the value of the lot.
Assume that Al is in the 38% incremental income tax
bracket (combined state and federal taxes) throughout
the 20 years.
In this analysis Al estimates that the income an.d
expenses will remain constant at their present levels.
If he buys and holds the property for 20 years, what
after-tax rate of return can he expect to receive on his
investment, using the following assumptions?
(a)Al believes the building and the lot can be sold at
the end of 20 years for the $9000 estimated value
of the lot.
(b)A more optimistic estimate of the future value of
the building and the lot is that the property can
be sold for $100,000 at the end of 20 years.
12-15 Zeon, a large, profitable corporation, is considering
adding some automatic equipment to its production
facilities. An investment of $120,000 will produce an
initial annual benefit of $29,000, but the benefits are
expected to decline $3000 per year, making second-
year benefits $26,000, third-year benefits $23,000,
and so forth. If the firm uses sum-of-years' -digits de-
preciation, an 8-year useful life, and $12,000 salvage
value, will it obtain the desired 6% after-tax rate of
return? Assume that the equipment can be sold for its
$12,000 salvage value at the end of the 8 years. Also
assume a 46% income tax rate for state and federal
taxes combined.
12-16 A group of businessmen formed a corporation to lease
for 5 years a piece of land at the intersection of two
busy streets. The corporation has invested $50,000
in car-washing equipment. They will depreciate the
equipment by suin-of-years'-digits depreciation, as-
suming a $5000 salvage value at the end of the 5 year
useful life. The corporation is expected to have a
before-tax cash flow, after meeting all expenses of
operation (except depreciation), of $20,000 the first
year, declining $3000 per year in future years (second
year =$17,000, third year= $14,000, etc.). The cor-
poration has other income, so it is taxed at a combined
corporate tax rate of 20%. If the projected income is
correct, and the equipment can be sold for $50oo.at
the end of 5 years, what after-tax rate of return would
the corporation receive from this venture?
(Answer: 14%)
12-17 The effective combined tax rate in an owner-managed
corporation is 40%. An outlay of $20,000 for certain