Ch. 3 - Taxes as Transaction Costs Flashcards
Every business activity consists of a……
series of transactions intended to generate profit and create value.
What is the first step in evaluating a business transaction?
To quantify the cash flows from the transaction.
Net cash flow
The difference between cash received and cash disbursed
Time value of money
A dollar available today is worth more than a dollar available tomorrow because the current dollar can be invested to start earning interest immediately.
A dollar available today has the present value of a dollar. The present value of a dollar available in the future is based on a discount rate—the after-tax rate of interest on invested funds for the deferral period.
Discount rate
The rate of interest used to calculate the present value of future cash flows.
Net present value (NPV)
The sum of the present values of cash inflows and outflows from a transaction.
Annuity
A cash flow consisting of a constant dollar amount available at the end of the period for a specific number of equal time periods
True or false: in business-decision making process, cash flows before tax should be considered
False—in the business decision-making process, cash flows before tax have no relevance
Tax cost
An increase in tax liability for any period resulting from a transaction
If a transaction results in an increase in any tax for the period, the increase is a __________
cash outflow
If a transaction results in a decrease in any tax cost for any period, the decrease is a ________
cash inflow
Tax savings
A decrease in tax liability for any period resulting from a transaction
In the income tax system, tax liabiliyt is based on _________ rather than ___________
Net business profits rather than gross revenues
Deduction
An offset or subtracting in the calculation of taxable income
Marginal tax rate
The rate that applies to the next dollar of income
Private Letter Ruling
The IRS’s written response to a taxpayers inquiry as to how the tax law applies to a proposed transaction
Market
A forum for commercial interaction between two or more parties for the purpose of exchanging goods or services.
Private market
A market in which the parties deal directly with each other and can customize the terms of their agreement to meet their respective objectives.
Arm’s length transaction
A transaction occurring between unrelated parties who are dealing in their own self interest.
Public markets
A market in which the parties deal indirectly through an intermediary such as a broker or financial institution
Related party transactions
A transaction between parties who share a common economic interest or objective and who may or may not be dealing at arm’s length
True or false: related party transactions are never at arm’s length
False—they may or may not be dealing at arm’s length
