Ch. 3 - Taxes as Transaction Costs

Question 1

Every business activity consists of a……

Answer 1

series of transactions intended to generate profit and create value.

Question 2

What is the first step in evaluating a business transaction?

Answer 2

To quantify the cash flows from the transaction.

Question 3

Net cash flow

Answer 3

The difference between cash received and cash disbursed

Question 4

Time value of money

Answer 4

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.

Question 5

Discount rate

Answer 5

The rate of interest used to calculate the present value of future cash flows.

Question 6

Net present value (NPV)

Answer 6

The sum of the present values of cash inflows and outflows from a transaction.

Question 7

Annuity

Answer 7

A cash flow consisting of a constant dollar amount available at the end of the period for a specific number of equal time periods

Question 8

True or false: in business-decision making process, cash flows before tax should be considered

Answer 8

False—in the business decision-making process, cash flows before tax have no relevance

Question 9

Tax cost

Answer 9

An increase in tax liability for any period resulting from a transaction

Question 10

If a transaction results in an increase in any tax for the period, the increase is a __________

Answer 10

cash outflow

Question 11

If a transaction results in a decrease in any tax cost for any period, the decrease is a ________

Answer 11

cash inflow

Question 12

Tax savings

Answer 12

A decrease in tax liability for any period resulting from a transaction

Question 13

In the income tax system, tax liabiliyt is based on _________ rather than ___________

Answer 13

Net business profits rather than gross revenues

Question 14

Deduction

Answer 14

An offset or subtracting in the calculation of taxable income

Question 15

Marginal tax rate

Answer 15

The rate that applies to the next dollar of income

Question 16

Private Letter Ruling

Answer 16

The IRS’s written response to a taxpayers inquiry as to how the tax law applies to a proposed transaction

Question 17

Market

Answer 17

A forum for commercial interaction between two or more parties for the purpose of exchanging goods or services.

Question 18

Private market

Answer 18

A market in which the parties deal directly with each other and can customize the terms of their agreement to meet their respective objectives.

Question 19

Arm’s length transaction

Answer 19

A transaction occurring between unrelated parties who are dealing in their own self interest.

Question 20

Public markets

Answer 20

A market in which the parties deal indirectly through an intermediary such as a broker or financial institution

Question 21

Related party transactions

Answer 21

A transaction between parties who share a common economic interest or objective and who may or may not be dealing at arm’s length

Question 22

True or false: related party transactions are never at arm’s length

Answer 22

False—they may or may not be dealing at arm’s length