Question

Vern plans to invest $100,000 in a growth stock, in year 0. The stock is not...

Vern plans to invest $100,000 in a growth stock, in year 0. The stock is not expected to pay dividends. However, Vern predicts that it will be worth $135,000 when he sells it in year 3. The $35,000 increase in value will be taxable at the preferential capital gains rate of 15 percent.

a. Using a 4 percent discount rate, calculate the net present value of after-tax cash flows from this investment. (Round discount factor(s) to 3 decimal places. Round your intermediate calculations and final answer to the nearest whole dollar amount.)

b. Which two of the four basic tax planning variables increase the value of Vern's investment?

Check All That Apply

Time period variable

Character variable

Entity variable

Jurisdiction variable

Business   Accounting   
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Homework Answers

Answer #1

Net Cash Received on Sale = 135000 – tax

= 135000 – (35000*15%)

=129750

Discount Rate = 4% , PVF at the end of 3 yr = 0.889

Therefore, Present Value of After Tax Cash flows = 129750*0.889 = 115347.75

Net Presnt Value = Present Value of Cash Inflows – Present Value of Cash Outflows

= 115347.75-100000 = $15,347.75

b. Variables that can increase the value of investment are:

Time period variable: Shorter the time period, lesser will be the loss of time value of money

Entity Varible: Different entities are subject to different rates of tax. Adopting a tax sturcture which lowers the tax rate for Vern can increase the value of his investment

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