** LOL ** Bandhu Jayagopal and his wife, Padmini, are the founders and current owners of the Riverview Restaurant and Lounge. They retired several years ago from the day-to-day management, however, turning it over to a nephew, Mehmood Shah. Shah has run the restaurant very profitably, but recent redevelopment of the downtown riverfront area has brought new competition to the Riverview. Jayagopal’s 25 year old grandson, Jeff Patel, thinks the restaurant can leap ahead of the competition and attract a hipper crowd by turning the lounge into a nightclub. Patel wants to incorporate a new business and lease the restaurant lounge for his nightclub, the Red Monkey. Patel has consulted a contractor who says he can do the renovations for $25,352,000. Patel estimates that the new sound system and décor would be usable for five years before fashions changed enough that it would have to be replaced, at which point it would have no salvage value. Patel assures his grandfather and uncle that he could generate $14,384,000 in revenue every year once the renovations are complete. For their parts, Jayagopal and Shah are understandably leery of turning over the financial future of the family business to a 25 year old who wants to open a club. Since the new club would face the same 41% tax rate that the restaurant faces, Jayagopal and Shah are not sure that the cash flow from the club would be sufficient to cover the rapid depreciation of the fashionable décor. The fact that Patel also expects them to fund the new company for him doesn’t help. They say no. Patel returns to his uncle and grandfather armed with financial projections. Patel shows his hoped-for business partners that, if they use the straight-line method in reporting the club’s results, the Red Monkey will report $5,495,024 in after-tax income (ignoring expenses other than depreciation) in the first year. Jayagopal counters that straight-line depreciation is irrelevant because for tax purposes the depreciation schedule will be accelerated to 35% per year in each of the first two years and 30% in the third year. Jayagopal points out that after-tax income for the club in the first year will be only $3,251,372 on a tax basis (again ignoring expenses other than depreciation). Shah joins Jayagopal in his objections, adding that the accelerated depreciation schedule used for tax purposes will result in a substantial deferred tax liability, reaching approximately $4,158,000 by the end of year three. Patel replies that the deferred tax liability is merely an accounting entry and the Red Monkey will never have to pay any of it since the club will reinvest in up-to-date décor in five years when the current renovations are out of fashion. Patel adds that a change in the tax law to cut tax rates from 41% to 31% is likely in year three, and if that happens the deferred tax liability at the end of the third year will decline to $2.948 million. Jayagopal agrees about the likelihood of a tax cut, saying that such a cut in tax rates would add $1.014 million to the Red Monkey’s reported net income in year three. Jayagopal and Shah agree to fund the nightclub if the tax cut passes. What would be the Red Monkey’s projected tax payable (in millions) in year one?
You have one minute
1 answer should be way off, so your chances are 1/3!
In 2009 the way-off answer will disappear–so your chances are, er, still 1/3. Damn.
yeah those long qbank questions are a joke. i always put B in that instance.
wtf? that took me more than one minute to read.
At least it’s a relatively simple question - Instead of reading the whole thing, just jot down the numbers and their significance.