6. ABC Inc. is a nonprofit and thus pays no corporate taxes. XYZ Inc. is a for-p

Question

6. ABC Inc. is a nonprofit and thus pays no corporate taxes. XYZ Inc. is a for-profit firm whose current corporate tax rate is 40%. They are in the same business. In setting up operations, ABC chose to use fewer fixed assets (plant and equipment). As a result of that, they have higher expenditures on working capital (in a sense, substituting inventories for machines). Why did XYZ choose more fixed assets and lower working capital expenditures? (Hint: Focus on corporate taxes.) Both of these companies are considering getting a new copier. Which of them is more likely to lease it? Why?

Explanation / Answer

XYZ Inc. is a for-profit firm and thus gets tax advantage on depreciation by choosing more fixed assets and lower working capital expenditures.

Say, Profit of XYZ= 100

Less: Depreciation= 30

Balance profit= 100-30= 70

Corporate taxes= 70*40% =28

If there was no depreciation, corporate taxes would amount to 100*40% = 40, which implies that depreciation lead to savings in taxes by 12(40-28). Which is why it is beneficial for XYZ to choose more fixed assets.

New Copier- ABC Inc. (nonprofit) is more likely to lease the copier, as it involves less unfront cost. While XYZ Inc. (profit) is more likely to buy the copier to get corporate tax advantage on depreciation.

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