When evaluating new projects and investments, the ABC Corporation calculates after-tax cash flows and earnings assuming the firm’s marginal tax rate equals the top federal statutory tax rate of 35%. The firm is a large multinational with operations in many foreign countries as well as many states in the United States.
a. Under what future profitability conditions is it advisable for the ABC Corporation to use the statutory tax rate in its project evaluations?
b. What problems might arise by ignoring foreign, state, and local taxes in these project evaluations?
c. The firm’s financial accountant calculates that the company’s effective tax rate is 25% and argues that the firm should be using this rate in its project evaluations. Do you agree? Suppose the ABC Corporation, due to the Asian economic crash and Internet-based competition, faces some uncertainty about its future profitability.
d. What effect might this uncertainty have on the firm’s marginal tax rate?
e. Given this uncertainty, the firm’s CFO, who is concerned about the firm being in the wrong investment and financing clientele, asks you to prepare a memo outlining possible actions, together with your recommendations, that the firm might take to reduce the expected costs of finding itself being in the wrong clientele. She asks that any assumptions you make be made explicit.