Question

Multinational Co. (MNC) generated $1,500 million in domestic earnings before interest, taxes, and amortization (EBITA). MNC amortizes intangible assets at $275 million per year and takes a $160 million interest expense. MNC's statutory (domestic) tax rate is 21.5 percent on earnings before taxes, but only 15 percent on foreign operations. MNC has $150 million of pre-tax foreign income and generates $35 million in ongoing research and development (R&D) tax credits. What is its effective tax rate on pre-tax profits? a) 16.7% b) 17.8% c) 21.5% d) 23.3% e) 10.8%

Answer 1

Step 1: Calculate Total Amount of Tax Expense

The total amount of tax expense is determined as below:

Tax on Domestic Earnings = (EBIT - Amortization - Interest Expense)*Domestic Tax Rate = (1,500 - 275 - 160)*21.50% = $228.975

Tax on Foreign Income = Pre-Tax Foreign Income*Tax Rate on Foreign Operations = 150*15% = $22.50

Total Tax Expense = Tax on Domestic Earnings + Tax on Foreign Income - Research and Development (R&D) Tax Credits = 228.975 + 22.50 - 35 = 216.475

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Step 2: Calculate Effective Tax Rate

The value of effective tax rate is arrived as follows:

Effective Tax Rate = Total Tax Expense/Total Income before Taxes = 216.475/((1,500 - 275 - 160) + 150) = 17.8% (which is Option B)