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Chapter 1 Problem Answers

1. Chapter 1 Study Problem 1-3 answer:

Sanderson, Inc. Corporate Income Tax

Sales $3,000,000
Cost of Goods Sold (2,000,000)
Gross Profits $1,000,000
Cash Operating Expenses (400,000)
Depreciation Expenses (100,000)
Operating Profits 500,000
Dividend Income $50,000
Less 70% Exclusion (35,000) 15,000
Interest Expense (150,000)

Taxable Income $365,000

Tax Liability
$50,000 x 0.15 = $7,500
25,000 x 0.25 = 6,250
290,000 x 0.34 = 98,600
235,000 x 0.05 = 11,750
$124,100

2. Chapter 1 Study Problem 1-7 answer:

J.P. Hulett, Inc. Corporate Income Tax

Sales $4,000,000
Cost of Goods Sold (3,000,000)
Gross Profits $1,000,000
Cash Operating Expenses (500,000)
Depreciation Expenses (350,000)
Operating Profits 150,000
Dividend Income $12,000
Less 70% Exclusion (8,400) 3,600

Taxable Income $153,600

Tax Liability
$50,000 x 0.15 = $7,500
25,000 x 0.25 = 6,250
78,000 x 0.34 = 26,724
53,600 x 0.05 = 2,680
$43,154
3. Chapter 1 Study Problem 1-9 answer:

G.R. Edwin, Inc. Corporate Income Tax

Sales $6,000,000
Cost of Goods Sold (3,000,000)
Gross Profits $3,000,000
Operating Expense (2,600,000)
Interest Expense (30,000)

Taxable Income $370,000

Tax Liability
$50,000 x 0.15 = $7,500
25,000 x 0.25 = 6,250
295,000 x 0.34 = 100,300
235,000 x 0.05 = 11,750
$125,800

Average tax rate = $125,800 = 34%


$370,000

Marginal tax rate = 34%

Hint: The marginal tax rate = average tax rate = 34% in the $335,000 - $10M range.

4. Chapter 1 Study Problem 1-10 answer:

The Anatoly Corporation Corporate Income Tax

Sales $4,500,000
Cost of Goods Sold
and Cash Operating Expense (3,200,000)
Depreciation Expense (50,000)
Operating Profit 1,250,000
Interest Expense (150,000)
Long-term Gain:
Selling Price $120,000
Purchase Price (40,000) 80,000
Taxable Income $1,180,000

Tax Liability
$50,000 x 0.15 = $7,500
25,000 x 0.25 = 6,250
1,105,000 x 0.34 = 375,700
235,000 x 0.05 = 11,750
$401,200
4. (Cont)

A $10,000 increase in taxable income for Anatoly would result in a ($10,000 x 34%) $3,400
increase in taxes owed. The total tax liability would be 401,200 + 3,400 = $404,600. Be certain
for these types of problems that you answer the question that is asked, “How much will Anatoly’s
tax liability increase/decrease by as a result of this new information?,” NOT “What is Anatoly’s
total tax liability including this new income?”

5. answer:

$30,000 x .17 = $5,100 depreciation expense in the 3rd year of operation

6. answer:

a) Year Depreciation expense


1 $85,500 x 33% = 28,215
2 $85,500 x 45% = 38,475
3 $85,500 x 15% = 12,825
4 $85,500 x 7% = 5,985
$85,500

b) Compute the annual tax savings of the depreciation expense using the marginal tax rate of
34%.

Year Tax Savings


1 $28,215 x 34% = 9,593.10
2 $38,475 x 34% = 13,081.50
3 $12,825 x 34% = 4,360.50
4 $ 5,985 x 34% = 2,034.90
$29,070.00

c) Straight-line annual depreciation expense would be $85,500/3 = $28,500/year. Annual tax


savings are $28,500 x .34 (marginal tax rate) = $9,690/year

d) Year Tax Savings (MACRS) Tax Savings (SL)


1 9,593.10 9,690
2 13,081.50 9,960
3 4,360.50 9,960
4 2,034.90 0
$29,070.00 $29,070

While the total tax savings over time are the same, the timing of the tax savings are quite
different. There is very little difference in the first year between MACRS and SL.
However, the tax savings using MACRS is significantly greater than using SL in the
second year and slightly greater in the fourth year. However, the savings in year three are
greater using SL.

e) With MACRS, the significant depreciation expense occurs sooner and, as a result, is
preferred. In upcoming weeks, we can calculate just how much better MACRS is than SL.
7. answer:

J.P. Hulett, Inc. Corporate Income Tax

Sales $4,000,000
Cost of Goods Sold (3,000,000)
Gross Profits $1,000,000
Cash Operating Expenses (500,000)
Depreciation Expenses (350,000)
Operating Profits 150,000
Dividend Income $12,000
Less 70% Exclusion (8,400) 3,600
Taxable Income $153,600
Tax Liability (using info in problem) (153,600 x .35) (53,760)
Non Taxable Dividends 8,400
Net Income $108,240
Dividends Paid (3,000)
Addition to Retained Earnings $105,240

Cash flow generated from operations = $108,240 + $350,000 = $458,240

Cash inflow = $4,000,000 + $12,000 = $4,012,000


Cash outflow = $3,000,000 + $500,000 + $53,760 = ($3,553,760)
$ 458,240