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CFA Level I · CFA Level I Exam · Analysis of Income Taxes

An analyst reconciles a company's statutory tax rate of 30% to its effective tax rate of 24%. The only reconciling item is a lower rate applied to income earned in a foreign subsidiary. The company's pretax income is 500 million and the subsidiary contributes 200 million of it, taxed at 15%. The remaining income is taxed at 30%. The effective tax rate computed this way is closest to:

Foreign income of 200 million taxed at 15% gives 30 million, and the other 300 million taxed at 30% gives 90 million. Total tax is 120 million on 500 million of pretax income, so the effective tax rate is 24%.

  1. A21%
  2. B24%Correct
  3. C27%

Explanation

Tax on foreign income = 200 x 15% = 30. Tax on the remaining 300 x 30% = 90. Total tax = 120, and 120/500 = 24%. Using 30% on all income gives 150, or 30%, which is the statutory rate and not the effective rate.

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