Question

In: Accounting

Sal, a calendar-year taxpayer, uses the cash-basis method of accounting for his sole proprietorship. In late...

Sal, a calendar-year taxpayer, uses the cash-basis method of accounting for his sole proprietorship. In late December he performed $50,000 of consulting services for a client. Sal typically requires his clients to pay his bills immediately upon receipt. Assume that Sal's marginal tax rate is 32 percent this year and 37 percent next year and that he can earn an after-tax rate of return of 7 percent on his investments. Should Sal send his client the bill in December or January? Use Exhibit 3.1. (Round discount factor(s) to three decimal places.)

EXHIBIT 3-1 Present Value of a Single Payment at Various Annual Rates of Return
4% 5% 6% 7% 8% 9% 10% 11% 12%
Year 1 .962 .952 .943 .935 .926 .917 .909 .901 .893
Year 2 .925 .907 .890 .873 .857 .842 .826 .812 .797
Year 3 .889 .864 .840 .816 .794 .772 .751 .731 .712
Year 4 .855 .823 .792 .763 .735 .708 .683 .659 .636
Year 5 .822 .784 .747 .713 .681 .650 .621 .593 .567
Year 6 .790 .746 .705 .666 .630 .596 .564 .535 .507
Year 7 .760 .711 .665 .623 .583 .547 .513 .482 .452
Year 8 .731 .677 .627 .582 .540 .502 .467 .434 .404
Year 9 .703 .645 .592 .544 .500 .460 .424 .391 .361
Year 10 .676 .614 .558 .508 .463 .422 .386 .352 .322
Year 11 .650 .585 .527 .475 .429 .388 .350 .317 .287
Year 12 .625 .557 .497 .444 .397 .356 .319 .286 .257
Year 13 .601 .530 .469 .415 .368 .326 .290 .258 .229
Year 14 .577 .505 .442 .388 .340 .299 .263 .232 .205
Year 15 .555 .481 .417 .362 .315 .275 .239 .209 .183

Solutions

Expert Solution

Alternative 1 : If Bill is send in December

Cash receipts 50000
less:Tax expense {50000*.32} (16000}
After tax income if bill is send in December 34000

Alternative 2 :If Bill is send in January

Cash receipts 50000
less:present value of Tax expense (17297.5)
After tax income if bill is send in January 32702.50 (rounded to 32703)

#Tax expense if bill is send in January :50000*37%= 18500

present value of tax expense at 7% for 1 year = PVF7%,1*Tax expense

                                                              = .935 * 18500

                                                              = 17297.5

Since after tax income is greater if bill is send in December ,bill must be send in month of December


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