Question

Reese, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December, she received a $31,000 bill from her accountant for consulting services related to her small business. Reese can pay the $31,000 bill anytime before January 30 of next year without penalty. Assume Reese’s marginal tax rate is 30 percent this year and will be 40 percent 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 she pays the $31,000 bill in December?b. What is the after-tax cost if she pays the $31,000 bill in January?

Answer 1

Answer:

a) The after-tax cost if she pays the bill in December is $21,700

b) The after-tax cost if she pays the bill in January is $19,306.80

Explanation:

a)  If she pays the $31,000 bill in December

Present value tax savings = amount × marginal tax rate

= $31,000 × 30%

= $9,300

After-tax cost = Pre-tax cost - present value tax

= $31,000 - $9,300

= $ 21,700

b)  If she pays the $31,000 bill in January

Present value tax savings = amount × marginal tax rate

= $31,000 × 40%

= $12,400

Calculation of discount factor = Present value = $\frac{FutureValue}{(1+r)^{n} }$

=  $\frac{1}{(1+0.06)^{1} }$

= 0.943

Present value tax savings = amount × discount factor

= $ 12,400 × 0.943

= $11,693.20

After-tax cost = Pre-tax cost - present value tax

= $31,000 - $11,693.20

= $ 19,306.80