Question

A financial analyst becomes excited hearing the news of a potential corporate tax-cut. The government is going to lower the tax rate from 35% to 21%. He thinks a lower rate will lessen the tax bill on the proposed project and thus, increase the net income. However, when working on his capital budgeting problem, he notices that the net income of his project actually goes down under the new lower tax rate – exactly opposite of what he expected. Explain why might this happen.

Answer 1

Situation 1

When the tax rate goes down, it is an advantage to not only us but also for our competitors. So due to tax cuts, well established competotors will be able to sell their products at lower prices. So this affects our sales and income. When sales fall, our revenue decreases.

Situation 2

Here the government is going to lower the tax rate from 35% to 21%. The reason for the government to lower the tax rate could be the market / eceonomic recession. Although the tax rate has dropped, due to recession in the market sales may also have dropped drastically, ultimately resulting in reduced  income.