Assignment:
Suppose a firm is equally likely to earn $2 million this year or lose $3 million. The firm faces a tax rate of 40% on each dollar of taxable income, and the firm pays no taxes on losses. In this simple one-period scenario, ignore the carryback and carryforward rules. The firm’s expected taxable income is thus a loss of $500,000 calculated as .50(−$3) + .50($2). What is the firm’s expected marginal tax rate?
Suppose a second firm is equally likely to earn $3 million this year or lose $2 million. This firm also faces a tax rate of 40% on each dollar of taxable income (and the firm pays no taxes on losses). Again in this simple one-period scenario, ignore the carryback and carryforward rules. The firm’s expected taxable income is thus a profit of $500,000 calculated as .50($3) + .50(−$2). What is the firm’s expected marginal tax rate?
Explain and discuss your results. Why is the first firm’s marginal tax rate not 0%? Why is the second firm’s marginal tax rate not 40%?
Provide complete and step by step solution for the question and show calculations and use formulas.