Question

The marginal tax rate of a firm is displayed as below:

Taxable Income -- Tax rate

$0 - $5 -- 10%

$5 - $10 --20%

$10 - --30%

A firm has its taxable income as the following:

Probability ---Pre-tax income

0.4--- $10m

0.6--- $30m

(1) Assume the company could purchase a zero-loading insurance policy. How much tax saving by purchasing the insurance policy? (2) What if the insurance policy has a 30% loading?

Answer 1

Working Note 1-Calculaton of Average Expected Income

Probability	Pre-tax income	Probable Income
0.4	$10m	4
0.6	$30m	18
Total Probable Income = 22
Average Probable Income = 22/2
Expected Income will be $11m

Working Note 2

Calculation of Tax Payable
Particulars	Applicable Rate	Tax Amt
Tax on First $5	10%	$0.50
Tax on Next $5	20%	$1.00
Balance $1	30%	$0.30
Total Tax Payable		$1.80

(1) Assume the company could purchase a zero-loading insurance policy.
Ans :- If Company Could purchase a Zero Loading Policy then No Tax Benefit will be provided
(2) What if the insurance policy has a 30% loading?
Ans: If Insurance Policy has a 30% Loading then Tax Payable would be as below

Total Tax Payable	$1.80
Less Tax Benefit equal to Policy loading	Less 30% of &1.80
Net Payable	$1.3%m