- Suppose that firms face 40% income tax rate on positive profitsand that net losses receive no credit. (Thus, if profits arepositive, after-tax income is (1 – 0.4) * profit, while if there isa loss, after-tax income is the amount lost.) Firms A and B havethe same cash flow distribution as in problem 5 above. Suppose theappropriate effective annual discount rate for both firms is 10%?
- What is the expected pre-tax profit for A and B?
- What is the expected after-tax profit for A and B?
- What would Firms A and B pay today to receive next year’sexpected cash flow for sure, instead of the variable cash flowsdescribed above?
Here I attach problem 5, so you can see the info for problem 6,problem 6 is the one that I want to get the answer.
Problem 5.
- Suppose that firms face 40% income tax rate on all profits. Inparticular, losses receive full credit. Firm A has 50% probabilityof a $1000 profit and a 50% probability of a $600 loss each year.Firm B has a 50% probability is a $300 profit and a 50% probabilityof a $100 profit each year.
