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LEARNING OUTCOMES
At the end of this module, you are expected to:
1. Illustrate the SAVANT framework and its importance to tax planning.
Pre-Activity
Please review the topics discussed in your BAINCTAX class.
INTRODUCTION
To increase firm value, managers engage in transactions. Of course, firm value can increase for
other reasons. For example, the value of the firm’s assets simply can appreciate due to market
factors beyond the control of managers. However, transactions must have occurred when firms
acquire such assets, and it takes transactions to convert such assets into cash flow.
Managers do things like buy, sell, rent, lease, and recapitalize. If managers structure transactions
such that each is value-maximizing, then by year-end the sum of such transactions will have
maximized firm value. However, note that each transaction has an uninvited third party: the
government. In strategic tax management, when a firm chooses transactions, it keeps tax
management in mind.
SAVANT FRAMEWORK
The firm looks to engage in transactions that maximize end-of-period value. It can chose from a
constellation of entities or transactions, and the choice then is put through the lens of the firm’s
strategic objectives. If the transaction (including tax effects) is consistent with the firm’s strategic
objectives, it may accept the transaction. Otherwise, even if the transaction is highly tax-
advantaged, the firm should consider rejecting the transaction.
Similarly, the tax aspects of the transaction can be managed in a strategic manner.
Next, the firm anticipates its future tax status and chooses the timing—this year or a future year—
of the transaction. Because the effects of transactions often span more than one year, the firm
projects tax effects into the future, using current and expected future tax rates and rules, and
factors in management’s expectations as to the future tax status of the firm. If there is tax
advantage to adjusting the timing of a transaction, the firm should do so, provided that the nontax
economics still make sense.
Taxes are also negotiated between the firm and the other entity. The firm seeks to shift more of
the tax burden away from itself (and potentially, onto the other entity) by negotiating the terms
of the transaction. The firm attempts to minimize tax costs by transforming transactions being
considered into ones with more favorable tax treatment. For example, managers can work to
restructure transactions that might generate nondeductible costs into ones where costs are
deductible ones, or work to transform what would have been ordinary income into capital gain
income.
What is left, after taxes, is value-added to the firm. Like taxes, value-added often inures to the
firm over time. Because it is a fundamental principle that cash inflows are more valuable now
than later, tax management takes into account the time value of a transaction as well. The time
value of a transaction, after taxes and transaction costs, is what increases firm value in the future.
One aspect of a transaction that affects value-added comprises transaction costs, such as sales
commissions or attorney fees. Transaction costs reduce the net value of the transaction to the firm.
If the transaction costs exceed the net value, the transaction should be rejected.
As explained previously, SAVANT is an acronym for strategy, anticipation, value-adding,
negotiating, and transforming. For a transaction to be properly tax managed (and thus best
increase firm value), managers should consider all of these aspects.
STRATEGY
A key ingredient of any successful organization is a sound and successfully implemented
strategy. Tax management should work to enhance the firm’s strategy and should not cause the
firm to engage in tax-minimizing transactions that deter it from its strategic plan. As an extreme
example, a firm could earn zero profits and pay no taxes, but this would be inconsistent with
sound strategy. In a business setting, strategy can be thought of as the overall plan for deploying
resources to establish a favorable position.
Strategy provides a vision of where the firm wants to go, typically represented by a mission
statement. For example, a mission statement might be “to be the global leader in widget
manufacture.” A more specific business-level strategy is a way to gain an advantage over
competitors by attracting customers to the firm and away from competitors. Such strategies
typically boil down to doing things better, cheaper, or faster than the competition.
The firm’s business-level strategy is typically detailed in operations-level, corporate-level, and
international-level strategies.
The firm’s strategy involves gaining advantage over competitors to create
value for its customers through its products or services. The operations
focus has resulted in many firms reengineering the process by which they
Operations Level
execute their business-level strategy. In its competitive analysis, the firm
needs to understand whether it has a tax advantage or disadvantage in
relation to its rivals.
Corporate strategy focuses on diversification of the business. Ideally,
diversification strategies improve the structural position or process
Corporate Level
execution of existing units, or, in a new business unit, stresses competitive
advantage and consumer value.
International strategy focuses on taking advantage of corporate and
International
business strengths in global markets. It requires an understanding of local
Level
countries and relies on working with foreign governments.
As part of the firm’s strategy, it needs to deal with the threats shown below.
How does effective tax management interact with strategy? First, a firm should not alter the
form of a transaction in order to manage taxes, if the change is inconsistent with its strategy. For
example, if a firm wants to acquire another business that is unrelated to its core competency, to
obtain tax benefits, it should not do so unless it is clear that the pretax economics make sense.
Second, a firm’s competitive strategy may be shaped, in part, by its tax status. Put simply, if a
firm is structured so that it has a more favorable tax status than that of its competitors, this can
give the firm an overall cost advantage over its competitors. Effective tax management is an
important tool in obtaining this kind of competitive edge.
Illustration 10.1 EFFECT OF TAX STATUS ON COMPETITIVE STRATEGY
Suppose the Philippine government announces a 50% additional income tax deduction for the
depreciation of a new developmental equipment purchased. Both a firm and its biggest
competitor are thinking about acquiring new equipment for their product line. The firm is in
the 30% regular rate and the competitor will be in an NOL situation throughout the useful life
of the equipment. Assume the equipment costs P1,000,000 and has a residual value of P200,000
at the end of its useful life of five years.
The after-tax cost of the equipment would be computed as follows:
Firm Competitor
Total Depreciation 800,000 800,000
Special Deduction 400,000 400,000
Total Deductible Expense 1,200,000 1,200,000
Regular Income Tax Rate 30% 0%
Tax Shield 360,000 0
Deduct to: Cost 1,000,000 1,000,000
After-Tax Cost 640,000 1,000,000
The firm can use this cost advantage to buy more equipment, cut prices (and undercut the
competitor), or invest in new projects.
Illustration 10.2 EFFECT OF TAX STATUS ON COMPETITIVE STRATEGY
Assume the same facts from Illustration 10.1. Both firms have P20 pretax unit contribution
margins. Each sells a product for P40 and has fixed costs consisting solely of depreciation of the
new equipment.
The after-tax cost of the equipment would be computed as follows:
Firm Competitor
After-Tax Cost 640,000 1,000,000
Residual Value 200,000 200,000
Depreciable After-Tax Cost 440,000 800,000
Useful Life 5 5
Depreciation as Fixed Cost 88,000 160,000
After-Tax Contribution Margin per Unit 14 20
Break-Even Point in Units 6,286 8,000
The strategic advantage goes to the firm, because it achieves break-even sales at a much lower
volume.
ANTICIPATION
Firms operate in a dynamic environment in which they must attempt to anticipate the actions of
their competitors, markets, and governments. Tax-managing firms adjust the timing of
transactions in anticipation of expected tax changes. Firms adjust the timing of their transactions
when they are certain of their future tax status or when there is a known change in tax rules. For
example, they might know that they have an NOL this year, which will be used next year.
Certain Tax Changes
Suppose it is known that tax rates will rise substantially next January. If it is now December, the
rate change can be anticipated. Assuming it is not otherwise harmful, simply delaying December
expenses until January means they will have more “bang for the buck” that month by being
deducted at a higher tax rate.
At the corporate level, timing usually focuses on shifting income to lower-tax-rate years and
deductions into higher-rate years.
Illustration 10.3 DEDUCTIONS AND CERTAIN CHANGES IN TAX RATE
A company is considering purchasing a new computer system. The new system would cost
P500,000 and would generate first-year depreciation deductions of P70,000. The current tax rate
is 30% and is expected to be reduced to 25% in the next year due to a nearly enacted tax cut law.
The tax benefit would be computed as follows:
Current Year Next Year
First-Year Depreciation 70,000 70,000
Tax Rate 30% 25%
Tax Benefit 21,000 17,500
The company would be better off in purchasing the computer system in the current year as it
would realize incremental tax benefit of P3,500.
Illustration 10.4 INCOME AND CERTAIN CHANGES IN TAX RATE
A corporation is considering selling some unimproved land to generate cash flows. The land
would generate a P1,000,000 taxable gain. The current tax rate is 30% and is expected to be
reduced to 20% in the next year due to a nearly enacted tax cut law.
The tax benefit would be computed as follows:
Current Year Next Year
Taxable Gain 1,000,000 1,000,000
Tax Rate 30% 20%
Tax Implication 300,000 200,000
The company would be better off in selling the land in the next year as it would result to tax
savings of P100,000.
Uncertain Tax Changes
The tax-managed firm can anticipate tax changes before they become official. Employing this
anticipation strategy entails assigning a probability to the likelihood of tax legislation being
enacted.
Illustration 10.5 UNCERTAIN TAX CHANGES
A company has an annual budget of P100,000 for a two-year productivity incentive bonus
available to its employees. The firm’s lobbyists estimate that there is a 20% probability that the
50% R&D special deduction will not be extended for the next year.
The tax benefit of following the annual budget would be:
Tax Shield Probability Amount
First Year (100,000 x 50% x 30%) 15,000 100% 15,000
Second Year (100,000 x 50% x 30%) 15,000 80% 12,000
Tax Benefit 27,000
The tax benefit of advancing the whole budget on the current year would be:
Tax Shield Probability Amount
First Year (200,000 x 50% x 30%) 30,000 100% 30,000
The company should consider accelerating next year’s productivity incentive bonus at the
current year as it would result to incremental tax benefit of P3,000. Of course, the firm needs to
consider whether the acceleration makes good business sense.
Price Effects
Competitors can also react to expected tax changes. At a minimum, a widespread reaction has
supply-and-demand effects in some markets, causing a price change. Tax cuts cause prices to rise,
and tax increases cause prices to fall. (In this way, changes in market prices can mute the effects
of tax policy.) This price effect has become known as implicit taxes.
Firms should attempt to anticipate price effects resulting from tax changes. The magnitude of
price effects depends on a number of conditions. These include the elasticities of supply and
demand and whether additional suppliers can enter the market. (This can occur to some degree
in the long run.) In practice, such elasticities may not be known, although marketing departments
of large firms often have data on price sensitivities to their own products. The point here is that
some sort of a price response is likely to occur no matter what types of goods, services, or
investments receive the tax break.
Illustration 10.6 PRICE EFFECTS
Suppose a manager knows that on January 1 of next year, a 10% tax credit will be given for the
purchase of a new computer system. The manager expects to spend P100,000 on a networked
system of PCs to replace an existing system. Assume an additional P8,000 must be spent in
programmer time to get the system up and running.
Generally, the manager would assume that the tax savings on the new system of P10,000 (10%
× P100,000) will pay for the P8,000 programming costs. However, if the market price, (from
increased demand) jumps to around P103,000, then even with the tax break, the anticipated net
benefit will be negative.
Increased Price 103,000
Tax Rate 10%
Tax Benefit 10,300
Incremental Costs (103,000 – 100,000) (3,000)
Programming Costs (8,000)
Net Tax Benefit (700)
VALUE-ADDING
Effective tax management is no different from any other aspect of management insofar as any
transaction should at some point be expected to add value. Ultimately, most measures of value-
adding are derived from the firm’s financial statements. Related to accounting earnings are the
firm’s cash flows. If the net present value of cash flows from a transaction is positive, then, over
time, this will translate into positive financial earnings. Both typically enhance shareholder value
and increase management compensation.
Using Cash Flows to Measure Value-Adding
The key thing to remember is that if managers maximize after-tax cash flows on each transaction,
this may also maximize shareholder value, as measured by financial income. Therefore,
discounted cash flow (DCF) analysis is critical in measuring whether a tax management method
will increase firm value.
Illustration 10.7 CASH FLOW AS MEASURE OF VALUE-ADDING
Suppose a firm buys some unimproved land, in year 1, as an investment, for P1,000,000. At the
end of year 2, it sells the land for P2,500,000. The firm’s net income before the land transaction,
and before management bonuses, for years 1 and 2 is P10,000,000 and P11,000,000, respectively.
There are 100,000 shares of common outstanding. Management receives a bonus of 5% of pretax
income.
The value-adding effects from the land transactions are:
Purchase Price (1,000,000)
Selling Price 2,500,000
Tax on Gain on Sale
Selling Price 2,500,000
Purchase Price (1,000,000)
Gain on Sale 1,500,000
Tax Rate 30% (450,000)
Management Bonus
Gain on Sale 1,500,000
Bonus Rate 5%
Amount of Bonus 75,000
Tax Shield 70% (52,500)
Net Cash Flows 997,500
The cash-flow analysis yields the same measure of value-adding as does financial accounting
income: a P997,500 increase. The only difference between the cash flows and reported earnings
is when they are reported. Shareholder value increases by a P9.975 per share earnings per share
(EPS); management wealth increases by P75,000 (before they pay their own taxes). Note that
cash flows will rarely exactly equal the sum of financial earnings changes over time. However,
they will approximate it.
Value-Adding, Cash Flows, and Time Value
A tenet of business is that a peso of income now is worth more than a peso later. Holding tax rates
and bases constant, tax management implies deferring income and accelerating deductions. More
formally, it is the net present value (NPV) of expected taxes which managers should work to
minimize. This implies that not only cash flows, but also discounted cash flows, should be used
in determining whether a transaction increases after-tax firm value.
Illustration 10.8 TIME VALUE OF MONEY
A firm can make one of two investments. Both have three-year horizons, and both have identical
pretax cash flows of P100,000 per year. The taxes for the first investment are P60,000 in total,
that is, P20,000 in each of the three years. The taxes for the second investment are also P60,000,
but the tax is all due in the third year. The firm has a 10% cost of capital.
The present value of investments will be computed as follows:
Cash Flow PV Factor Discounted CF
First Investment 20,000 2.4869 49,738
Second Investment 60,000 0.7513 45,078
Simply through the time value of deferring the tax, the second investment has a higher value-
adding to the company.
Illustration 10.9 DISCOUNTED NET CASH FLOWS
Assume the same facts for Illustration 10.7 and cost of capital of 8%.
The present value of taxable event will be computed as follows:
Cash Flow PV Factor Discounted CF
Purchase Price (1,000,000) 1.0000 (1,000,000)
Selling Price 2,500,000 0.8573 2,143,250
Tax on Gain on Sale (450,000) 0.8573 (385,785)
Management Bonus (52,500) 0.8573 (45,008)
Discounted Net Cash Flows 712,457
Using Other Measures of Value-Adding
The previous discussion is not meant to imply that DCF is the only method of value increase. On
a year-by-year basis, investors and creditors monitor the firm’s financial performance. Because
DCF information (especially on individual projects) is rarely communicated directly to outsiders,
they usually must rely on measures of performance that can be constructed from publicly
available financial statement data. Managers thus need to know how transactions affect such
measures.
EVA has become increasingly popular. It is computed as after-tax operating profit minus the
firm’s weighted-average cost of capital. Accordingly, even if a transaction minimizes taxes, it may
be poor tax management if it decreases EVA.
Illustration 10.10 ECONOMIC VALUE ADDED
Suppose a firm acquires a new plant, which increases annual pretax operating profits by
P1,000,000. Because of the tax benefits of accelerated depreciation, assume there is no tax on the
increased earnings. To finance the plant, the firm issues P1,000,000 in bonds that pay 8%. Prior
to the transaction, the firm had P100,000,000 in after-tax operating profits, and capital consisting
of P200,000,000 in common stock having a cost of 14%.
EVA before and after the acquisition would be computed as follows:
Before After
After-Tax Operating Profit 100,000,000 101,000,000
Less: Cost of Capital
Before (14% x 200,000,000) 28,000,000
After (28,000,000 + 8% x 1,000,000) 28,800,000
Economic Value Added 72,000,000 72,200,000
Thus, from an EVA standpoint the project should be accepted, since it increases annual EVA by
P200,000. However, before a definite decision on the new plant can be made, there should be an
NPV analysis to consider multiperiod effects (such as tax depreciation becoming smaller in later
years).
It is important to note that exclusive use of EVA (or ROE) is not recommended for evaluating
long-term projects. For example, suppose the new plant from the preceding illustration had
P1,000,000 in losses in its first two years but P1,500,000 in positive income in subsequent years.
Suppose that, when added together, the new plant had a positive NPV. If managers are overly
concerned with shareholder response, they might reject the project because, in the short run, EVA
(as well as ROE and EPS) is negative.
Maximizing Value-Adding and Potential Conflicts
Maintaining (or improving) value-adding is implicitly a contract between the manager and the
firm’s shareholders. Closely related are explicit contracts based on financial accounting
information. The company may have debt covenants tied to certain financial ratios. Therefore, a
transaction, while saving taxes, might be detrimental overall if it results in financial rations that
violate these covenants. For example, suppose a transaction saves P100,000,000 in taxes.
However, it is financed with debt that, when added to the firm’s existing debt, causes the debt-
to-equity ratio to exceed the maximum specified in debt covenants. If it costs the firm over
P100,000,000 to renegotiate the debt, the transaction should be rejected. Other contracts based on
financial accounting could be with managers (e.g., bonuses), customers, or suppliers.
To see this, refer to Illustration 10.7. Suppose that you are the chief financial officer of the
corporation and are trying to decide whether to invest in the raw land. Recall that the P1,000,000
investment would generate negative cash flows in year 1 and would not have a positive EPS (or
other financial statement) impact until year 2. If the firm’s middle managers, who receive bonuses
based on EPS, can invest P1,000,000 in another project that has a positive EPS impact this year, it
may be difficult to persuade them to make the land investment, even if that land investment
would have a higher after-tax NPV.
So how should one measure the value-added of a tax-related transaction to shareholders? Use
NPV, but also consider any important financial statement measures and financial statement-
linked contractual issues.
Value-Adding and Transaction Costs
Tax management requires that the tax savings exceed the related execution costs in any
transaction. Transaction costs might include brokers’ fees or legal and accounting costs. Some
examples of transactions costs are:
Stock broker fees on the sale of stock
Attorney, accountant, and investment banker charges on mergers, acquisitions, and
recapitalizations
Lobbying costs to obtain favorable tax structures prior to locating a new plant
Temporary loss of funds when paying an expense in December instead of January
NEGOTIATING
Effective tax planning involves negotiating tax benefits, both with tax authorities and with other
entities involved with the firm in a taxable transaction. Negotiation with a nongovernmental
party to a transaction is a function of the relative tax status of the parties. That is, the benefits or
costs can be shifted between the parties by negotiating the purchase price.
Illustration 10.11 NEGOTIATING
Suppose a firm is selling an office building with a market value of P2,000,000, of which tax
benefits (through depreciation) are worth P300,000.
If the selling entity is in a nontaxpaying situation (e.g., a nonprofit organization that is exempt
from income tax), the tax benefits are worth nothing, so the firm should be willing to sell for
less than P2,000,000. A taxable purchaser should be willing to pay up to P2,000,000.
TRANSFORMING
Tax management also includes transforming certain types of income into gains, certain types of
expenses into losses, and certain types of taxable income into nontaxable income. Regarding the
latter, losses on sales of capital assets (raw land, financial instruments) are deductible only to the
extent that the firm has capital gains. Thus, the firm would like to transform capital losses to
ordinary losses. In general, tax management seeks these transformations:
One significant example of gain transformation is the sale of stock. If the corporation sells
appreciated assets and then distributes the proceeds to shareholders, the corporation pays taxes
on the gain, and the shareholders have income subject to final tax on the dividend. Instead, if the
corporation liquidates, the appreciation is taxed to the corporation, but the subsequent
distribution to the shareholders likely is taxed to them as capital gains. If the shareholder is an
individual (as opposed to a corporate parent), the maximum tax rate on the gain is 35%. This
transformation method may save the shareholder a significant amount of taxes.
Illustration 10.12 TRANSFORMING
The sole shareholder of a small corporation’s stock wants to sell the business. The proposed
sales price would be P1,000,000, which is the fair market value of the corporation’s assets. The
shareholder’s tax basis in the stock is P300,000, and the corporation’s basis in assets is P200,000.
If the corporation sells the assets, then distributes the cash to the shareholder in liquidation, the
corporation must pay tax (at the standard 30% rate) on the sale, and the shareholder must pay
tax at the marginal tax rate of 32% on the capital gain. This would result in P636,000 of after-tax
cash flow to the shareholder.
Sale Price of Assets 1,000,000
Less: Corporate Tax
Sale Price of Assets 1,000,000
Less: Tax Basis 200,000
Gain to Corporation 800,000
Corporate Tax Rate 30% 240,000
Cash Given to Shareholder 760,000
Less: Shareholder Tax on Liquidation
Cash Received by Shareholder 760,000
Less: Tax Basis 300,000
Capital Gain 460,000
Marginal Tax Rate 32% 147,200
Net Cash Flow to Shareholder 612,800
If instead the shareholder sells the stock directly to a buyer, the net cash flow is:
Sale Price of Stocks 1,000,000
Less: Capital Gains Tax
Sale Price of Stocks 1,000,000
Less: Tax Basis 300,000
Capital Gain 700,000
Capital Gains Tax Rate 15% 105,000
Net Cash Flow to Shareholder 895,000
Selling the stock transforms ordinary income into capital gain. By doing so, the shareholder
increases his cash flow by P282,200.
A classic example of converting a nondeductible expense to a deductible one can be found in
identifying and properly documenting the business purpose for what appear to be non-
deductible personal expenses, such as meals, travel, and entertainment. Taking a friend to lunch
is not deductible; having a substantial business discussion with a potential client (who also is a
friend) can be.
References:
Karayan, J.E. & Swenson, C. (2007). Strategic Business Tax Planning. New Jersey: John Wiley & Sons, Inc.
Self-Check!
Basing on your readings, answer the following questions.
1. Differentiate tax minimization and tax optimization.
2. How does the SAVANT Framework operate in every transaction?
3. What is the connection of tax minimization to a taxpayer’s business strategies?
4. Differentiate treatment of new tax laws for financial accounting purposes and tax
planning purposes.
5. What are the measures of value-adding?
6. How can taxes be negotiated?
7. What are the usual transformations employed in tax planning?
Exercise 10.1 TRUE OR FALSE
Determine whether the following statements are true or false.
1. The SAVANT Framework operates on a transactions approach.
2. One of the other purposes of taxes is to further social engineering goals.
3. Taxes is not that important in structuring a transaction.
4. Locating operations in low-tax locations uses the strategic tax planning mechanism of
negotiating.
5. Transfer taxes help provide additional horizontal equity in the tax system beyond that
provided by the income tax.
6. Profits from sales of property other than inventory are generally classified as capital
gains.
7. Capital losses are more favorable than ordinary losses.
8. Consumption taxes are normally considered as progressive.
9. Negotiating involves finding ways to avoid taxes in the form of bribes.
10. Changes in tax rate are only considered for tax planning purposes if they are already
enacted.
Exercise 10.2 IDENTIFICATION
Identify the terminologies described in each statement.
1. Seeking to shift more of the tax burden away from itself and potentially, onto another
entity
2. Converting tax items to suit into a more favorable tax treatments
3. If there is tax advantage to adjusting the timing of a transaction, the firm should do so,
provided that the non-tax economics still make sense
4. Strategies involving gaining advantage over competitors to create value for its
customers through its products or services
5. Increase in firm value
Problem 10.1 EFFECT OF TAX STATUS ON COMPETITIVE STRATEGY
Assume the Philippine government has granted a 100% special allowable itemized deduction
on the depreciation of qualified purchase of a pioneer medical equipment. Each equipment
would cost P3,500,000 and has a residual value of P500,000 at the end of its ten-year useful life.
Assuming a 12% cost of capital, compute the after-tax cost of the equipment should it be
purchased by a:
a. Proprietary Hospital
b. Not-for-Profit Hospital
c. Government Hospital
Problem 10.2 CHANGES IN TAX RATE
Suppose a tax rule would increase the tax rate from 25% to 28% starting January 1, 2021. On
January 1, 2020, a lessee offered to its lessor to purchase a leased asset at a price of P500,000
above its book value. The lessor records P50,000 depreciation on the leased asset annually. The
lessor has a choice to sell the asset on January 1, 2021 should it refuse to sell it in 2020.
When is it more tax-favorable to sell the leased asset? By how much tax savings?
a. Assume said tax rule is already enacted
b. Assume said tax rule is still a bill and has a 60% chance of being enacted
Problem 10.3 PRICE EFFECTS
Suppose a new tax rule allows for 50% deduction for the depreciation of qualified assets.
Usually, the qualified asset costs P800,000. Initial operating cost would amount P15,000.
1. How much would the net tax benefit should the market price of the asset rise to:
a. P1,000,000
b. P900,000
2. Compute for the indifference point.
Problem 10.4 AFTER-TAX CASH FLOW
A company is considering investing in unlisted shares of a company with a par value of
P400,000 for P850,000. It plans to alienate it when the value of the stocks reaches P1,300,000. It
will pay the documentary stamp tax on the sale and broker’s commission of 1%.
How much is the after-tax cash flow of the investment?
Problem 10.5 TIME VALUE OF MONEY
An entity engages in a lease agreement which would raise P150,000 rental income for the next
ten years. Its cost of capital is 9%.
How much is the discounted tax cash flows?
Problem 10.6 ECONOMIC VALUE ADDED
An entity got a 10% P5,000,000 loan from the bank to finance an investment which results to an
after-tax profit of P800,000. Its Shareholders’ Equity showed a balance of P75,000,000 with a cost
of capital of 12.5%. The after-tax operating profit without the investment is P10,200,000.
How much is the incremental EVA arising from the investment?
Problem 10.7 NEGOTIATING
CityMed, Inc., a medical laboratory clinic, is about to close and plans to sell a specialized
medical equipment which has a market value of P6,000,000. The equipment would annually
generate P500,000 of tax deductions throughout its remaining useful life of ten years.
By how much lower should CityMed be willing to go lower on the selling price of the equipment
if it is to be bought by a:
a. Proprietary Hospital
b. Not-for-Profit Hospital
c. Government Hospital
Problem 10.8 TRANSFORMING
The sole shareholder of a small corporation’s stock wants to sell the business. The proposed
sales price would be P8,000,000, which is the fair market value of the corporation’s assets. The
shareholder’s tax basis in the stock is P2,500,000, and the corporation’s basis in assets is
P4,000,000. Assume the shareholder has a marginal tax rate of 35%.
How much is the tax savings if the gain is converted as capital gain?
