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Principles of Taxation Fall 2021 Topic 8: Problem set

1. The Xyz Corporation bought an asset worth 400.000 Euro in the current fiscal year. The tax code allows the application of the straight-line method over six years. (a) Compute the fiscal advantage assuming a corporate tax rate of 30%. (b) What would be the fiscal advantage of the other methods discussed in the lecture? Which one would be preferred (and under which circumstances) by the company? 2.

(a) How is the user cost of capital defined in the neoclassical model (hint: You may want to read page 445ff. of Rosen and Gayer to answer this question)? (b) Assume that the user cost of capital (C) is simply

C=

r+ ( 1 − Θ )( 1 − t)

(1)

where r is the after tax rate of return,  is the depreciation rate, Θ is the corporate tax rate and, t is the individual tax rate. Now assume further that the after tax rate of return is 10 percent and the economic depreciation rate is 2 percent. The firm faces corporate taxes of 35 percent with an individual tax rate of 25 percent. What is the user cost of capital in this case? (c) Suppose that we now know that the present value of depreciation allowances is 0.20. In addition, there is an investment tax credit of 0.10. How does this new information change your answer to Question b) ? What effect does this new information have on the user cost of capital? 3. The Xyz Corporation is now thinking about buying a new computer system that will yield a pre-tax return of 30%. This computer system will depreciate at a rate of 3% per year. The risk-less interest rate is 11% and the corporate tax is 35%. The average shareholder of Xyz faces a marginal tax rate of 30%. There are no tax credits and no depreciation allowances. Will the Xyz Corporation buy the new computer system?

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