Reference no: EM132018047

Suppose Sonics Inc. just started business this period. The firm purchased 400 units during the period at various prices as follows:

Date	Units	Unit Cost	Total
January	100	$10	$1,000
March	100	$12	$1,200
June	100	$14	$1,400
October	100	$15	$1,500
Total	400		$5,100

The firm sold 250 units at $30 each on the following dates:

Date	Units	Unit Price	Total Sales
February	75	$30	$2,250
May	90	$30	$2,700
August	75	$30	$2,250
December	10	$30	$300
Total	250	$30	$7,500

Required (assume the firm faces a marginal tax rate of 35%):

a. Calculate taxable income and taxes payable assuming the firm uses FIFO (first-in, first-out) for inventory costing purposes.

b. Calculate taxable income and taxes payable assuming the firm uses LIFO (last-in, first-out) for inventory costing purposes.

Discuss your results, including any nontax costs that might be associated with either inventory costing system.

Continued on next page

6. Assume Sonics Inc., from the prior exercise, uses LIFO with the periodic inventory system. Thus the LIFO cost of ending inventory at year 1 of 150 units is $1,600 (100 @ $10 + 50 @ $12). Suppose in year 2, Sonics reports the following purchases and sales:

Date	Units	Unit Cost/Price	Total
Purchases
June	100	$17	$1,700
Sales
July	200	$30	$6,000

Required:

a. Calculate taxable income and taxes payable (again assuming Sonics faces a marginal tax rate of 35%) for year 2. How many more units did Sonics sell than purchase? What is the difference in the unit cost and latest purchase price for each of these units?

b. Instead of purchasing 100 units in June, Sonics purchased 110 units. Recalculate taxable income and taxes payable.

c. Instead of purchasing 100 units in June, Sonics purchased 90 units. Recalculate taxable income and taxes payable.

d. How many units should Sonics have purchased to avoid dipping into earlier layers of inventory?

e. Do you notice any opportunities for Sonics Inc. to smooth reported net income (by varying the amount purchased relative to sales)? Are there any costs associated with this strategy? Does FIFO offer the same opportunities?

f. Suppose the top managers of Sonics are compensated, in part, by a bonus linked to reported net income. What inventory costing method might you expect the managers to favor? What costs to the firm arise from this choice?

Chapter 7

1. Suppose a firm is equally likely to earn $2 million this year or lose $3 million. The firm faces a tax rate of 40% on each dollar of taxable income, and the firm pays no taxes on losses. In this simple one-period scenario, ignore the carryback and carryforward rules. The firm's expected taxable income is thus a loss of $500,000 calculated as .50(-$3) + .50($2). What is the firm's expected marginal tax rate?

Suppose a second firm is equally likely to earn $3 million this year or lose $2 million. This firm also faces a tax rate of 40% on each dollar of taxable income (and the firm pays no taxes on losses). Again in this simple one-period scenario, ignore the carryback and carryforward rules. The firm's expected taxable income is thus a profit of $500,000 calculated as .50($3) + .50(-$2). What is the firm's expected marginal tax rate?

Explain and discuss your results.

4. Find the annual report for some publicly listed high-technology company that has losses. Refer to the tax footnote in the report to extract the NOL carryforward. Assume an after-tax discount rate of 10%.

Calculate the firm's marginal explicit tax rate using the Manzon (1994) market-value approach. Discuss and explain your result.