Using the information we calculated in question 4, we can recalculate the deferred tax liability for years one, two, and three using the lower tax rate:

Deferred tax liability for years one and two equals [($9.314 − $5.511) × 0.31] = $1.179 million. Deferred tax liability for year three equals ($9.314 − $6.778) × 0.31 = $0.786 million. Thus the deferred tax liability on Red Monkey’s balance sheet at the end of year three, after the change in tax rate, will be ($1.179 million + $1.179 million + $0.786 million) = $3.144 million. Alternately, we can calculate the deferred tax liability for year three directly as ($10.141 million × 0.31) = $3.144 million. Using either approach, Patel’s statement is incorrect.

We calculated in question 4 that the deferred tax liability in year three will equal $4.158 million. Thus, Red Monkey’s deferred tax liability will decrease by ($4.158 − $3.144) = $1.014 million due to the new lower tax rate. Thus, Red Monkey will have to make an adjustment of $1.014 million in tax expense in year three, which will result in an increase in net income of $1.014 million. Jayagopal’s statement is correct.