A farmer expects irrigation system will increase real operating receipts by $32,
ID: 2797063 • Letter: A
Question
A farmer expects irrigation system will increase real operating receipts by $32,000 per year but will also increase real operating expenses by $8,000. Suppose that the inflation rate is 5% and the marginal tax rate is 20%.
(i) What is the nominal net return at the end of year 3?
a. $29,172 b. $22,800
c. $27,783 d. $24,000
(ii) Calculate the nominal after-tax net return at the end of year 4.
a. $28,800 b. $27,360
c. $34,560 d. $23,338
I do NOT believe the answer is A or B for either question.
Explanation / Answer
Given details:
real receipts = $ 32,000
Real Expense = $ 8000
Inflation rate = 5%
Tax rate = 20%
i)
Nominal receipts for year 3 = Real receipts ( 1 + Inflation rate )3
Nominal Expenditure for year 3 = Real Expenditure ( 1 + Inflation rate )3
Nominal receipts for year 3 = Real receipts ( 1 + Inflation rate )3
= $ 32,000 ( 1.05 )3
= $ 32,000 ( 1.1576 )
= $ 37,044
Nominal receipts for year 3 = Real receipts ( 1 + Inflation rate )3
= $ 8000 ( 1.05 )3
= $ 8000 ( 1.1576)
= $ 9261
Nominal net return = Nominal receipts - Nominal Expenditure
= $ 37,044 - $ 9,261
= $ 27,783
Thus OPtion C is Correct
ii)
Nominal receipts for year 4 = Real receipts ( 1 + Inflation rate )4
= $ 32,000 ( 1.05 )4
= $ 32,000 ( 1.2155 )
= $ 38,896
Nominal receipts for year 4 = Real receipts ( 1 + Inflation rate )4
= $ 8000 ( 1.05 )4
= $ 8000 ( 1.2155)
= $ 9724
Nominal net return = Nominal receipts - Nominal Expenditure
= $ 38,896 - $ 9,724
= $ 29,712
After Tax net return = Nominal net return ( 1 - tax rate )
= $ 29,712 ( 1 - 0.2)
= $ 29,712 (0.8)
= $ 23,338
Thus Option D is correct
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