Certified Valuation Analyst (CVA) Practice Exam

To convert pre-tax rates to after-tax rates, you would:

1. Add the tax rate to the pre-tax rate

2. Subtract the tax rate from the pre-tax rate

3. Multiply the pretax rate by (1 - tax rate)

4. Divide the pretax rate by (1 - tax rate)

The correct answer is: Multiply the pretax rate by (1 - tax rate)

To convert pre-tax rates to after-tax rates, multiplying the pre-tax rate by (1 - tax rate) is the correct method. This calculation effectively adjusts the pre-tax return to reflect the impact of taxes on that return. When you multiply the pre-tax rate by the factor of (1 - tax rate), you are taking the entirety of the pre-tax rate and reducing it by the proportion of taxes that will be paid on that rate, resulting in the net or after-tax rate. For example, if the pre-tax return is 10% and the applicable tax rate is 30%, the after-tax return would be calculated as follows: 10% * (1 - 0.30) = 10% * 0.70 = 7%. This clearly illustrates how taxes reduce the effective return on an investment. The other options do not accurately reflect the process of calculating after-tax returns. Adding or subtracting the tax rate directly from the pre-tax rate would not yield a realistic after-tax rate; those operations do not properly account for the dilution effect taxes have on investment returns. Dividing the pre-tax rate by (1 - tax rate) would lead to an incorrect representation, potentially inflating the pre-tax rate rather than adjusting