Loretta Plans to Start a Small Business, Operated Through a Corporation

question 33

Multiple Choice

Loretta plans to start a small business, operated through a corporation. In year 0, she expects the corporation to generate a loss of $100,000. Subsequently, she expects the corporation to be profitable, and projects profit of $150,000 in year 1, and $250,000 in year 2. Loretta's personal marginal tax rate on ordinary income is 39.6%. Using a 10% discount rate, calculate the present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business does not make an S corporation election.

• A) $73,518 total tax cost
• B) $88,250 total tax cost
• C) $115,406 total tax cost
• D) $118,800 total tax cost

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Definitions:

Moral Hazard

A situation where one party in a transaction has the opportunity to take risks because the costs that those risks entail will not be borne by that party.

Portfolio Risk

The variability of returns from a portfolio of investments.

Utility Function

A mathematical representation that ranks preferences or satisfaction levels individuals derive from consuming goods and services.

Risk Averse

The tendency of individuals or entities to prefer certainty over uncertainty, often choosing safer options over riskier ones to minimize potential losses.