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Web Chapter 17 Tax-Advantaged Investments 57
Suggested Answers to Discussion Questions
1. a. Exemptions claims reduce the amount of taxable income. They reduce taxes by the marginal tax
b. Medical and dental expenses must exceed 7.5% of the adjusted gross income in order for the
c. The key factor in taking the standard deduction is the level of expenses. Typically, the taxpayer
b. Either may be cheaper depending on the method and the brokerage used. The put hedge is likely
c. If the amount of saving is relatively small, the costs may be disproportionately large in relation to
b. Instructors should be sure that students understand the differences between traditional, Roth and
e. Students should mention the higher contribution limits and employer matches associated with
4. Answers will vary by student.
Solutions to Problems
1. Ed Robinson’s income tax due on $35,000 of taxable income =
Marginal tax rate affects after-tax investment returns. Investments should be selected that best fit
2. a. Jean’s tax liability:
©2017 Pearson Education, Inc.
58 Gitman/Joehnk/Smart • Fundamentals of Investing, Thirteenth Edition
(2) The average tax rate is taxes due divided by taxable income:
c. The findings in (b) demonstrate the progressive nature of income taxes. Jean earns twice what
3. The Mendez’s income tax calculations (2009):
I. GROSS INCOME
II. ADJUSTMENTS TO GROSS INCOME
VII. TAX COMPUTATION
All of the Mendez’ income, including dividends and capital gains, would be taxed at the 10%
*Neither the 10% tax rate on capital gains and dividends for low income families nor the amount
4. a. Taxable income of $68,750:
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Web Chapter 17 Tax-Advantaged Investments 59
c. Taxable income of $70,750:
d. The tax credit reduces taxes by the full $2,000 while a deduction of the dame amount only
5. Initial cost of shares 300 $132 $39,600
Because Shawn has held the shares for more than 12 months, the sale of the shares now or in the
future would result in a capital gain taxable at the long-term capital gains rate. However, because of
the time value of money, there are reasons for deferring the gain as long as the future rate is the same
6. a. Using the put options, Karen’s transactions are as follows:
(1) Initial cost of 200 shares at $10 per share $2,000
With this strategy, Karen can benefit from future price increases because she does not have to
exercise the put option if the price goes up.
©2017 Pearson Education, Inc.
60 Gitman/Joehnk/Smart • Fundamentals of Investing, Thirteenth Edition
b. Using the deep-in-the-money call option:
c. With a put option, Karen’s after-tax position is $3,525. Using the deep-in-the-money call option,
it is $3,720. Determining the best strategy depends on the exact amount of the change in stock
7. Total income $48,000
Solutions to Case Problems
Case 17.1 Tax Planning for the Wilsons
This case problem applies some of the tax concepts introduced in this chapter and discusses strategies for
reducing the tax liability on investments.
a. (1)
Stock Calculation Gain (or Loss)
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Web Chapter 17 Tax-Advantaged Investments 61
(2)
Consolidated Power and Light $6,000
2017 L/T GAIN
From the perspective of tax savings, assuming that the stocks retain their current market value
b. Nichol’s advice indicates that he believes the future price of the Cargon stock will probably decrease.
c. If the price of this security were as volatile as noted, the deep-in-the-money call option would
probably not be the best action. In a situation where a price increase is expected, but there is also a
d. Taking the tax loss on Amalgamated Iron & Steel will allow the Wilsons to reduce their tax payments
e. As with all investment strategies, there are a number of options available to the Wilsons. Their overall
strategy, however, should be to maximize their after-tax gains. The next step should be to evaluate and
forecast the price behavior of the securities they presently hold. A put hedge should probably be
©2017 Pearson Education, Inc.
