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Isabel, a calendar-year taxpayer, uses the cash method of accounting for her sole proprietorship. In late December she received a $20,000 bill from her accountant for consulting services related to her small business. Isabel can pay the $20,000 bill anytime before January 30 of next year without penalty. Assume her marginal tax rate is 37 percent this year and next year, and that she can earn an after-tax rate of return of 12 percent on her investments. a. What is the after-tax cost if Isabel pays the $20,000 bill in December

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Answer:

A.$12,600

B.$13,393

Explanation:

a. Calculation for the after tax cost if pays on December

First step

Tax savings in current year = $20,000×37%

Tax savings in current year=$7,400

Second step is to find the After tax cost using this formula

Let plug in the formula

After tax cost = Cost of bill - Tax saving

After tax cost = 20,000-7,40

After tax cost=$12,600

Therefore the after tax cost if pays on December will be $12,600

b. Calculation for the after tax cost if pays on January

First step

Tax savings in next year = $20,000×37%

Tax savings in next year =$7,400

Second step the Present value of $1 at 12% for one year will give is 0.893

Third step

Present value of tax savings = $7,400×.893

Present value of tax savings =$6,607

Last step is to find the After tax cost using this formula

After tax cost=Cost of bill -Present value of tax savings

Let plug in the formula

After tax cost= $20,000-6,607

After tax cost=$13,393

Therefore the after tax cost if pays on January will be $13,393