Asset Share Pricing questions...

[victorandjenny]

I am reading Felblum paper and got some questions.
1. On page 227, in the part of "Federal Income Taxes", I read "Thus the pre-tax loss of $240 in the year of issue is an after tax loss of $156." This is surprising for me because I think
1a. The tax should be based on profit but not premium;
1b. The loss should not be reimbursed with tax.

2. In the paragraph following the one in the previous question, there come the terms of before-tax discount rate and after-tax discount rate. My understanding is like the following: if the investment income of one company is 7% annually, and this company use this rate to calculate the discount, then it should be 1/1.07~0.9346; if we consider the tax (assuming 35%), then the invest income after tax is 7%*65%=4.55%, then the after-tax discount is 1/1.0455~0.9565. Am I right? Or do you have better definition of before-tax discount and after-tax discount?


Thanks.

[asile]

Loss can offset your taxable income (or be carried forward as a NOL) - in effect, if you have a loss, you get 35% 'back' in the form of reduced taxes.

[Vorian Atreides]

Your 1a statement is true. So, with a pre-tax loss of $240, your taxes are reduced by $84.

From an accounting perspective, you're correct that this should not be accounted to the losses.

But Feldblum is not talking about the accounting perspective here, but from a managerial/business decision perspective. In this case, that $240 pre-tax loss would be the equivalent of a $156 after-tax loss so that all other aspects of the business are held the same.

[victorandjenny]

Thanks to both of you for your answer. Yes, I understand now that mathematically speaking, loss will be taxed considering profit decreases when loss increase.

Do you agree with my understanding about before-tax and after-tax discount? Thanks.