Short-term Strategy Decisions

The Whitley Corporation’s year-end is December 31, 2013. It is now October 1, 2013. The Whitley management team is taking a look at the prior nine months and attempting to make some short-term strategy decisions.

ACME WRITERS

Whitley has experienced steady growth over the five preceding years. The result has been a steadily increasing EPS. Last year, Whitley reported an EPS of 1.95.

This year, owing to a mild recession, Whitley’s sales have fallen off. Management is looking for strategies that can improve the appearance of the financial statements. At the same time, there is a need for new equipment in the plant. Despite the recession, Whitley has enough cash to make the purchase.

Based on the year’s performance to date and extrapolation of the results to year-end, management feels that the pretax financial accounting income for the year will be $200,000. Transactions from prior years have resulted in a deferred tax asset of $15,000 and a deferred tax liability of $70,000 at the beginning of 2013. The temporary difference of $37,500 that resulted in the deferred tax asset is expected to completely reverse by the end of 2013. The deferred tax liability resulted totally from temporary depreciation differences. There will be a pretax reversal of $42,500 in this temporary difference during 2013.

Based on currently enacted tax law, the purchase of the equipment will result in a future taxable amount of $50,000. Whitley management feels that it can wait four to six months to purchase the machine. Whitley’s tax rate is 40 percent.

ACME WRITERS

Write a response of 700 words to the following:

  • Determine the projected amount of income tax expense that would be reported if Whitley waits until next year to purchase the equipment.
  • Determine the projected amount of income tax expense that would be reported if Whitley purchases the equipment in 2013.
  • Explain why Whitley should/shouldn’t wait to purchase the equipment. Your answer should take into consideration the expected financial statement effects, as well as the effect on EPS. Support your conclusions with pro forma data. The number of shares that Whitley will use to calculate EPS is 55,500.
  • Determine the ethical considerations of this case.
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