Unit 7: Tax Planning for Managerial Decisions-I - Practice Quiz

1 Which tax deduction is generally available to the owner of a depreciable business asset?

2 Which payment is generally considered by a lessee when calculating the tax cost of leasing an asset?

3 Which factor should a business primarily compare when choosing between owning and leasing an asset?

4 In a normal lease arrangement, who receives the right to use the asset?

5 Which amount represents the expected value of an owned asset at the end of its useful period?

6 Under an instalment purchase system, ownership of the asset generally passes to the buyer at what time?

7 Under a hire-purchase system, ownership generally passes to the hirer when which event occurs?

8 A periodic hire-purchase payment commonly includes which two components?

9 What is a key benefit of purchasing an asset through instalments?

10 Which cost is normally charged because payment for an asset is deferred under hire purchase?

11 Which financing source requires the business to make interest payments?

12 Interest on capital borrowed for business purposes is generally treated as what?

13 What is one major advantage of using own funds to purchase an asset?

14 What does the opportunity cost of using own funds represent?

15 If deductible interest is and the tax rate is , what is the related tax saving?

16 What is the managerial decision between producing a component internally and purchasing it from a supplier called?

17 Which supplier-related amount is directly relevant when considering whether to buy a component?

18 Which manufacturing cost is usually relevant to a make-or-buy decision?

19 If making a component costs per unit and buying it costs per unit, which option is cheaper when no other relevant factors exist?

20 Which qualitative factor is important when deciding whether to manufacture or buy a component?

21 A company can buy a machine for ₹10,00,000 or lease it for five annual year-end rentals of ₹2,60,000. If purchased, the machine is depreciated equally over five years with no residual value. The tax rate is 30%, the discount rate is 10%, and the five-year annuity factor is 3.7908. Which alternative has the lower present value of after-tax cost?

22 When comparing ownership with leasing, which combination normally represents tax-related benefits available from owning the asset but not from a tax-deductible operating lease?

23 A machine is required for four years. Its purchase price is ₹8,00,000, and it qualifies for straight-line depreciation over four years. Its estimated taxable sale proceeds at the end are ₹80,000. Which cash flows should be included in the present value cost of ownership?

24 A machine costs ₹8,00,000 and is depreciated equally over four years. It can be sold for ₹80,000 at the end of year 4, when its tax book value is zero. The tax rate is 30%, the discount rate is 10%, the four-year annuity factor is 3.1699, and the year-4 discount factor is 0.6830. What annual year-end lease rental would make leasing and buying approximately equivalent?

25 A lessor offers a lower rental because it can efficiently use the asset's depreciation deductions and residual value. The lessee has insufficient taxable income to use depreciation deductions immediately. Which choice is most likely to be tax-efficient, assuming the rental reduction reflects these lessor benefits?

26 A company purchases equipment under an instalment arrangement. Each payment contains principal and interest. For tax-planning purposes, how should the payments generally be analysed?

27 Equipment with a cash price of ₹6,00,000 is purchased under an instalment system. The first year's stated interest is ₹40,000. The buyer is entitled to tax depreciation at 15% of cost. What is the total first-year deduction relating to depreciation and interest?

28 Under an instalment contract, legal ownership passes to the buyer immediately. Under a hire-purchase contract, it passes only after the final payment. If tax depreciation follows legal ownership, what is the immediate consequence?

29 A machine costs ₹5,00,000 in cash. Alternatively, it can be acquired for ₹1,00,000 immediately and three year-end payments of ₹1,50,000. Interest included in those payments is ₹50,000, ₹30,000, and ₹20,000 respectively. The tax rate is 30% and the discount rate is 10%. Ignoring depreciation because it is identical under both choices, which statement is correct?

30 A firm expects uncertain cash flows and is comparing an instalment purchase with a hire-purchase arrangement. Which contractual feature creates a significant additional risk under hire purchase if the firm defaults before the final payment?

31 Which comparison is most appropriate when deciding whether to purchase an asset using retained funds or borrowed capital?

32 A company borrows ₹10,00,000 at 12% annual interest to purchase an asset. It has sufficient taxable income, and its tax rate is 30%. What is the annual tax shield from the borrowing?

33 A loan carries an annual interest rate of 12%, and interest is fully deductible. If the corporate tax rate is 30%, what is the effective after-tax cost of debt?

34 A company can borrow at 12%, with interest fully deductible at a 30% tax rate. Alternatively, its own funds could earn an 11% taxable return elsewhere. Ignoring differences in risk and liquidity, which financing source has the lower economic cost?

35 A company borrows ₹8,00,000 to purchase machinery. First-year depreciation is 20% of cost, annual interest is ₹72,000, and the tax rate is 30%. Assuming both deductions are fully available, what is the first-year tax saving from depreciation and interest together?

36 A component can be manufactured for a cash variable cost of ₹70 per unit and an avoidable cash fixed cost of ₹10 per unit. Manufacturing also provides a depreciation deduction equivalent to ₹6 per unit. The supplier's price is ₹88 per unit and is fully deductible. If the tax rate is 30%, which alternative has the lower after-tax cost per unit?

37 A company has idle production capacity. The accounting cost of making a component includes ₹18 per unit of allocated factory rent that will continue even if the component is purchased. How should this rent be treated in the make-or-buy decision?

38 A company needs 10,000 components. Buying costs ₹100 per unit. Manufacturing requires variable costs of ₹72 per unit and a special machine costing ₹3,00,000 with no residual value. Both the purchase price and all manufacturing expenditures qualify for immediate deductions through expense or depreciation. At a 30% tax rate, which alternative is preferable?

39 The pre-tax cash cost of manufacturing is slightly below the supplier's price, but manufacturing deductions arise over five years while the supplier's price is deductible immediately. What is the best tax-planning approach?

40 Making one component requires two machine hours. These hours could generate a contribution of ₹12 per hour from another product. Direct and avoidable manufacturing costs are ₹55 and ₹5 per component respectively. A supplier offers the component for ₹78. All relevant costs are deductible at the same time, and the tax rate is 30%. Which option is preferable?

41 A company can purchase an asset for million. The present values of depreciation tax shields and after-tax residual value are million and million, respectively. Additional after-tax ownership costs have a present value of million. Alternatively, it may pay an equal lease rental at each year-end for four years. The tax rate is , the after-tax discount rate is , and . What is the maximum annual lease rental the company should accept?

42 A four-year lease requires rentals of million at the beginning of each year, at times . Each rental is deductible, but its tax saving is realized one year after payment. The tax rate is , and the discount rate is . Use discount factors , , , and for years through . If the asset's net present cost of ownership is million, which decision is optimal?

43 A company in a temporary tax-loss position is considering a three-year lease with rentals of million payable at each year-end. Lease deductions generate tax savings of , but each saving can be used only two years after the related payment. At a discount rate, use factors , , , , and for years through . The asset's net present cost of ownership is million. Which alternative is preferable?

44 An asset costs million. The present values of its depreciation tax shields and after-tax maintenance costs are million and million, respectively. A competing lease has a net present cost of million. The asset would be sold after four years, with sale proceeds taxed at . At an discount rate, the year-four factor is . What nominal sale price makes ownership and leasing equivalent?

45 A lease has a net present cost of million. Purchasing has a present cost of million before recognizing residual value. The expected after-tax discounted residual value is million. If the actual residual value is below expectation, what happens to the preferred decision?

46 A machine has a cash price of . A buyer pays immediately and finances the remaining through three equal annual instalments calculated at . The first year's interest is therefore . Tax depreciation is of the full cash price on the written-down-value basis, and the tax rate is . Assuming both interest and depreciation are currently deductible, what is the first-year tax shield?

47 Two contracts have identical cash prices and payment dates. Under Contract I, legal title passes to the buyer immediately, subject to the seller's charge for unpaid amounts. Under Contract II, the customer initially hires the asset and obtains title only after paying the final amount and exercising the purchase option. Which classification is correct?

48 An asset can be bought for immediately or through payments of now and at each of the next three year-ends. The instalment interest components are , , and in years , , and . Interest is deductible at a tax rate, while depreciation is identical under both choices. At a discount rate, use factors , , and . Which statement is correct?

49 A hire-purchase contract requires immediately and three year-end instalments of . The implicit interest rate is , and . What are the implied cash price and total finance charge, respectively?

50 An instalment offer requires now and at the ends of years and ; its interest components are and . A hire-purchase offer requires now and at the ends of years , , and ; its interest components are , , and . Interest is deductible at , depreciation is identical, and the discount rate is . Which offer has the lower after-tax present cost?

51 A company borrows million on April 1 at to acquire a machine. The machine is first put to use on October 1 of the same financial year and remains in use through March 31. Under the applicable rule, borrowing cost up to first use is capitalized, while subsequent interest is deductible. Tax depreciation is of actual cost, with the full rate available because the machine is used for at least days. What is the total current-year deduction from depreciation and post-use interest?

52 A company has tax EBITDA of million and pays million of interest on debt from an associated enterprise. Assume the tax law limits the current interest deduction to of EBITDA, with any excess carried forward, and the corporate tax rate is . What are the current deduction, carried-forward interest, and current tax shield?

53 An asset requires million for one year. Borrowing costs , and the entire interest deduction yields an immediate tax saving at year-end. If own funds have an after-tax opportunity return of , which financing source has the lower one-year economic cost?

54 A company borrows million at for one year. Because of tax losses, the interest tax shield arising at the end of year 1 can be used only at the end of year 3. At an discount rate, how much does this delay increase the present value of the after-tax interest cost compared with immediate use of the shield at the end of year 1?

55 A one-year loan has a face amount of million, an interest rate, and a nondeductible arrangement fee equal to of face value, paid at inception. Interest is deductible at a tax rate, and the tax shield is realized at year-end. Based on net loan proceeds, what is the effective one-year after-tax financing cost, and how does it compare with own funds having an opportunity cost?

56 A company needs components annually for four years. Buying costs per unit. Manufacturing would require variable costs of per unit, avoidable fixed costs of annually, and a machine costing million. The machine has no salvage value and is depreciated straight-line over four years. The tax rate is , the after-tax discount rate is , and . What is the incremental NPV of manufacturing rather than buying?

57 A component can be manufactured with variable cost of per unit and allocated fixed overhead of per unit, of which only is avoidable. Each component requires two constrained machine hours. Those hours could instead generate contribution of per hour from another product. A supplier offers the component for . Ignoring taxes because all relevant amounts have identical tax treatment, which decision is correct?

58 A company requires components annually for three years. Manufacturing entails variable and avoidable fixed costs of and per unit, respectively, plus equipment costing million. The equipment has no salvage value and is depreciated straight-line over three years. The tax rate is , the discount rate is , and . What supplier price per unit makes buying and manufacturing financially equivalent?

59 Manufacturing instead of buying would save of pre-tax operating costs annually for five years. It requires equipment costing million and additional working capital of . The equipment is depreciated straight-line to zero over five years and can be sold for at the end, fully taxable because its tax basis is zero. Working capital is fully recovered. The tax rate is , the discount rate is , , and the year-five discount factor is . What is the incremental NPV of manufacturing?

60 A company needs units. Manufacturing involves variable cost of per unit, avoidable fixed cost of , and expected warranty cost of per unit. Buying costs per unit, plus inspection cost of and expected supplier-defect cost of per unit. Buying would also release capacity that can earn contribution of . At a tax rate, all costs are deductible and the alternative contribution is taxable. What is the after-tax advantage of the preferred choice?