Question

Yellow Sand Recycling is evaluating the bowling alley project. During year 1, the bowling alley project is expected to have relevant revenue of 663,300 dollars, relevant variable costs of 241,600 dollars, and relevant depreciation of 73,200 dollars. In addition, Yellow Sand Recycling would have one source of fixed costs associated with the bowling alley project. Yellow Sand Recycling just signed a deal with Indigo River Media to develop an advertising campaign for use in the project. The terms of the deal require Yellow Sand Recycling to pay Indigo River Media either 132,400 dollars in 1 year if the project is pursued or 181,400 dollars in 1 year if the project is not pursued. Relevant net income for the bowling alley project in year 1 is expected to be 215,485 dollars. What is the tax rate expected to be in year 1?  Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

As the bowling alley project is pursued, the firm pays Indigo River Media $ 132400 for the advertising campaign and this expense is considered to be a fixed cost and treated as such.

Let the required tax rate be T % (in decimals)

Relevant Revenue = $ 663300

Less: Relevant Variable Cost = $ 241600

Less: Fixed Cost = $ 132400

Operating Profit = $ 289300

Less: Depreciation = $ 73200

Earnings Before Taxes = $ 216100

Less: Taxes @ T% = T x (216100)

Net Income = (1-T) x 216100 = $ 215485 (given)

Therefore, 1-T = (215485 / 216100) = 0.997154

T = 1 - 0.997154 = 0.002846 or 0.2846 %