Question

Firm A produces gadgets. The price of gadgets is $2 each. Firm A has total fixed costs of $1,000,000 and variable costs of $1 per gadget. The corporate tax rate is 40%. If the economy is strong, the firm will sell 2,000,000 gadgets. If the economy enters a recession, the firm will sell only half as many gadgets. If the economy enters a recession, the after-tax profit of firm A will be _______.

A. $0
B. $270,000
C. $90,000
D. $180,000

Answer 1

Answer:

The correct option is A,$0

Explanation:

The overriding assumption here is that the economy enters recession . which implies that only half of the budgeted sales is possible.

Revenue (2000,000*$2*1/2)          $2,000,000

Variable cost (2000,000*1/2*$1)    ($1,000,000)

contribution                                      $1,000,000

Fixed costs                                      ($1,000,000)

Profit before tax                                $0

Tax                                                     $0

profit after tax                                    $0

Since no profit is recorded, profit after tax is $0, as there is nothing on which could be charged

There would e profit if the economy was strong as fixed cost would have been covered over a wide range of output.

Answer 2

Answer:

A. $0

Explanation:

Fixed Cost (FC) = $1,000,000

Variable Cost (VC) = $1 per unit

Selling Price (S) = $2 per unit

Tax rate (r) = 0.40

Sales volume during recession (n) = 1,000,000

The profit, before taxes, is given by revenue from sales (R) subtracted by total cost (C):

$P=R-C\\P=S*n - (FC +VC*n)\\P=\ 2*1,000,000 -(\ 1,000,000+\ 1*1,000,000)\\P=\ 0$

Since there is no profit, the company has no taxable revenue, and the after-tax profit of firm A will be $0.