Firm E must choose between two business opportunities. Opportunity 1 will generate an $8,000 deductible loss in year 0, $5,000 taxable income in year 1, and $20,000 tax-able income in year 2. Opportunity 2 will generate $6,000 taxable income in year 0 and $5,000 taxable income in years 1 and 2. The income and loss reflect before-tax cash inflow and outflow. Firm E uses a 5 percent discount rate to compute NPV and has a 40 percent marginal tax rate over the three-year period.
a . Which opportunity should Firm E choose?
b. Would your answer change if Firm E’s marginal tax rate over the three-year period is 15 percent?
c. Would your answer change if Firm E’s marginal tax rate is 40 percent in year 0 but only 15 percent in years 1 and 2? Issue Recognition Problems Identify the tax issue or issues suggested by the following situations, and state each issue in the form of a question.