Corporation R signed a contract to undertake a transaction that will generate $3
ID: 2386703 • Letter: C
Question
Corporation R signed a contract to undertake a transaction that will generate $360,000 total cash tot he corporation. The cash will represent income in the year received and will be taxed at 35%. Corporation R will receive $200,000 in year 0 and $160,000 in year 1. The other party to the contract now wants to restructure the transaction in a way that would increase the total cash to $375,000 ( $215,000 received in year 0 and $160,000 received in year 1). However, R would recognize the entire $375,000 taxable income in year 0. If corporation R uses an 8% discount rate to compute NPV, should it agree to restructure the transaction?Explanation / Answer
In the first propasal Year 0 Net income 200,000 Tax @ 35% 70,000 Profit after tax 130,000 Year 1 Net income 160,000 Tax @ 35% 56,000 Profit after tax (a) 104,000 Present value of discounitng factor 8% (b) 1 Therfore, Present value of income after tax (a*b) 96,304 Total Present value of income from the contract 226,304 In the second proposal Year 0 Net income 215,000 Tax on 375,000 @35% 131,250 Net income after tax 83,750 Year 1 Net income (a) 160,000 Present value of discounitng factor 8% (b) 1 Therfore, Present value of income after tax (a*b) 148,160 Total Present value of income from the contract 231,910 Therefore, R should agree to restructure the transaction.