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Unformatted text preview: 3 Taxes as Transaction Costs Learning Objectives After studying this chapter, you should be able to: 1. Given the marginal tax rate, compute the tax cost resulting from an income- generating transaction and the tax savings resulting from an income tax deduction. 2. Integrate tax costs and savings into net present value calculations of after-tax cash flows. 3. Identify the reasons why assumptions concerning future tax costs and savings are uncertain. 4. Explain why a business strategy that minimizes tax costs is not necessarily the optimal strategy for a firm. 5. Explain why the parties to a private market transaction should consider the tax consequences of the transaction to both parties. 6. Distinguish between an arm's-length transaction and a related party transaction. n the introduction to Principles of Taxation for Business and Investment Plan- ning, we established the premise that the overall objective of business decisions is to maximize the value of the firm. The premise is relevant to managers who are employed to make decisions on behalf of the owners of the firm. Managers who make good decisions that enhance the value of owners' equity can expect to be well compensated for their success. Managers who make bad decisions that result in a decline in value can expect to lose their jobs. A variation of the premise holds true for individuals acting in their own economic self-interest. People want to make per- sonal financial decisions that further their goal of wealth maximization. I In Chapter 3, we will explore the business decision-making process. We begin by examining the concept of net present value of cash flows as the cornerstone of this process. The chapter then focuses on how the tax consequences of business transactions affect net present value and how these consequences must be inte- grated into the decision-making framework. We will consider how managers can structure transactions to control tax consequences and maximize net present value. The chapter concludes by discussing the extent to which the various parties to a business transaction can negotiate to reduce the tax burden on the transaction and to share the tax savings among themselves. 52 Part Two Fundamentals of Tax Planning The Role of Net Present Value in Decision Making Every business operation consists of a series of transactions intended to generate profit and create value for the owners of the firm. Business managers obviously need a method for evaluating whether an isolated transaction or an integrated sequence of transactions will contribute to or detract from the profitability of the operation. The method should be useful to managers who must choose between alternative transactions that accom- plish the same functional result for the firm....
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- Spring '11