Question

In: Finance

Suppose the IRS imposes a 20% tax on profits. Return to the original situation (200 pairs,...

Suppose the IRS imposes a 20% tax on profits. Return to the original situation (200 pairs, 80 price per pair sold, 60 operating cost per pair).

-How much tax is paid?

-What are “Before-Tax Profits,” After-Tax Profits” and “After-Tax ROE?”

-Similar to the in-class example, what are the percentage changes in revenue, taxes, before- and after-tax profits due to a ten percent increase in unit sales?

-Say a weakening macro-economy causes shoe sales to decline to 110. What are “Before-Tax Profits,” After-Tax Profits” and “After-Tax ROE?”

Keep sales at 200 pairs. But labor costs (wages, benefits, pensions) jump to 75/pair from 40. Perform the same calculations. Why is this loss making situation qualitatively different from the above?

Solutions

Expert Solution

Net Profit on selling 200 pairs = 200 * (selling price - operating cost) = 200 * (80 - 60) = 2000 (Ans)

Hence, total tax paid = 2000 * 20% = 400 (Ans)

Before Tax Profit = 2000 (Ans)

After Tax Profit = 2000 - 400 = 1600 (Ans)

After Tax ROE = it cannot be calculated. ROE = Net Income / Shareholder Equity. We know net income, however shareholder equity is not given in the problem. Hence, ROE cannot be calculated.

2nd Scenario: 10% increase in sell

new sell figure = 110% * 200 = 220 pairs

new revenue = 220 * (80) = 17600. previous revenue was 200 * 80 = 16000

Percentage change in revenue = (17600 - 16000) / 16000 = 10% (Ans)

new tax = 2200 * 20% = 440. Old tax was 400

Tax Percentage change = (440 -400) /400 = 10% (Ans)

new before tax profit = 220 * (80 -60) = 4400. Old before-tax profit = 200 * (80 - 60) = 4000

%tage change = (4400 - 4000) / 4000 = 10% (Ans)

Similarly, after-tax profit change will be 10% as well (Ans)

3rd Scenario: shoe sale declines to 110

before-tax profit = 110 * (80 -60) = 110*20 = 2200 (Ans)

After-tax profit = 110*(80 - 60)*20% = 2200 * 20% = 440 (Ans)

After-tax ROE cannot be calculated for the same reason stated earlier (as stakeholder equity is not mentioned here).

4th Scenario: increased labour cost

Before-tax profit = 200 * (80 -75) = 1000

after-tax profit = 100* 20% = 200

This situation is more loss making, compared to earlier scenario. It is due to the fact labour cost/ operating cost has increased a lot. Compared to that, selling price of 80 has remained constant.  (Ans)

jeff jeffy answered 3 months ago
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