Suppose you paid 500000 for an asset You hold the asset for

Suppose you paid $500,000 for an asset. You hold the asset for five years. The interest rate that you get for the asset is 10% per year. Assume the tax rate on capital gains is 20%. 2. (A) If capital gains are taxed only when the asset is realized, how much will you have earned orn the asset? (2 marks) (B) Suppose that capital gains are taxed annually instead of at realization. How much will you have earned on the asset? (2 marks) (C) How big is the difference between the two taxing schemes? (1 mark)

Solution

Answer:

Price of asset, P = $ 500000

Interest earned, i=10%

Capital Gain Tax rate,r = 20%

A)

Capital gain = selling price - cost

Selling price = P(1+r)^t = 500000(1+0.1)⁵ = $ 805255

Capital gain = 805255 - 500000 = $ 305255

B)

When capital gain is paid annually

Gain = $500000(1+(0.1×0.8))⁵ - 500000

= 500000×1.46932 - 500000

= 734664 - 500000

= $ 234664

C)

Difference = $305655 - 234664 = $ 70591