FIN3403 Chapter One Cheat Sheet
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Corporate taxes
- Tantor Supply, Inc., is a small corporation acting as the exclusive distributor of a major line of sporting goods. During 2021 the firm earned $1,863,600 before taxes.
a.
Calculate the firm's tax liability using a flat tax rate of 21%.
1,863,600 x .21 = 391,356
b.
How much are Tantor Supply's 2021 after-tax earnings?
391,356 - 1,863,600 = 1,472,244
c.
What was the firm's average tax rate?
Average Tax Rate = Tax Liability / Earnings Before Taxes
o
$1,863,600$391,356 ≈ 0.2097 or 20.97% rounded up -> 21%
d.
What was the firm's marginal tax rate?
Marginal Tax Rate is the Flat Tax rate so it is 21%
Interest versus, dividend income
- Last year, Shering Corporation had pretax earnings of
$495,000. In addition, during the year it received $24,000 in income from interest on bonds it held in Zig Manufacturing and received $24,000 in income from dividends on its
5% common stock holding in Tank Industries, Inc. Shering faces a flat 21% tax rate and is
eligible for a 50% dividend exclusion on its Tank Industries stock.
a.
Calculate the firm's tax on its operating earnings only.
Tax on Operating Earnings = Operating Earnings x Flat Rate Tax
o
$495,000 x 0.21 = $103,950
b.
Find the tax and the after-tax amount attributable to the interest income from Zig Manufacturing bonds.
The
before-tax amount for the interest income is the amount received during the year from interest on bonds held in Zig Manufacturing. Interest income is not eligible for a 50% dividend exclusion since it is not a dividend. To calculate the tax on the interest
income, use the following
formula:
o
Tax on interest income = Taxable amount x Tax rate
o
The after-tax amount is calculated as
After-tax amount = Before-tax amount – Taxes
o
The tax and the
after-tax
amount attributable to the interest income are shown
below
Interest Income
Before-tax amount
$24,000
Less: Applicable exclusion
0
Taxable amount
$24,000
Tax (21%)
$5,040
After-tax amount
$18,960
o
With interest income of $24,000, Shering Distributors will pay $5,040 in taxes. The
after-tax amount is $18,960
c.
Find the tax and the after-tax amount attributable to the dividend income from the Tank Industries, Inc., common stock.
The before-tax amount for the dividend income is the amount received during the year from dividends on the 5% common stock holding in Tank Industries, Inc. Dividend income is eligible for a 50% dividend exclusion. To calculate the tax on the dividend income, use the following formula:
o
Tax on dividend income = Taxable amount × Tax rate
o
The after-tax amount is calculated as:
i.
After-tax amount = Before-tax amount − Taxes .
The tax and the
after-tax
amount attributable to the dividend income are shown
below
Dividend Income
Before-tax amount
$24,000
Less: Applicable tax exclusion
$24,000 x .50 = $12,000
Taxable amount
$12,000
Tax (21%)
$2,520
After-tax amount
$21,480
Shering Distributors will pay only $2,520 in taxes on $24,000 of dividend income which is eligible for the 50% dividend exclusion. Thus, $12,000 of the $24,000 dividend income is not taxed. The dividend after-tax amount is $21,480. d.
Compare, contrast, and discuss the after-tax amounts resulting from the interest income and dividend income calculated in parts b.
and
c.
The
after-tax amount of dividends
received, $21,480
, exceeds the
after-tax amount of
interest, $18,960
, due to the 50%
corporate dividend exclusion.
This increases the attractiveness of stock investments by one corporation in another relative to bond investments.
e.
What is the firm's total tax liability for the year?
Total tax liability = Taxes on operating earnings + Taxes on interest income + Taxes on dividend income. Therefore,
Total tax liability = $103,950 + $5,040 + $2,520 = $111,510
Hemingway Corporation is considering expanding its operations to boost its income, but
before making a final decision, it has asked you to calculate the corporate tax consequences of such a decision. Currently, Hemingway generates before-tax yearly income of $202,000 and has no debt outstanding. Expanding operations would allow Hemingway to increase before-tax yearly income to $343,000. Hemingway can use either cash reserves or debt to finance its expansion. If Hemingway uses debt, it will have a yearly interest expense of $69,000. Create a spreadsheet to conduct a tax
analysis (assume a 21% flat tax rate) for Hemingway Corporation and determine the following:
To calculate the current tax liability:
Tax liability = Before-tax income × Tax rate
Tax liability = $202,000 × 21% = $
42,420
b.
If Hemingway finances its expansion using cash reserves, what will be its new corporate tax liability
Tax liability = $343,000 x 21% = $72,030
c.
If Hemingway finances its expansion using debt, what will be its new corporate tax liability?
Tax liability = ($343,000 − $69,000) X 21% = $57,540
d.
What would you recommend the firm do?
Then, the expansion using debt would be recommended because it provides a tax savings of $14,490 (the tax bill is $57,540 for the "expansion-using-cash" option versus $72,030 for the "expansion-using-
debt" option)
Assessing the Goal of Sports Products, Inc. Loren Seguara and Dale Johnson both work for Sports Products, Inc., a major producer of boating equipment and accessories. Loren works as a clerical assistant in the Accounting Department, and Dale works as a packager in the Shipping Department. During their lunch break one day, they began talking about the company. Dale complained that he had always worked hard trying not to waste packing materials and efficiently and cost-effectively performing his job. In spite of his efforts and those of his co-
workers in the department, the firm's stock price had declined nearly $2.00 per share over the past 9 months. Loren indicated that she shared Dale's frustration, particularly because the firm's profits had been rising. Neither could understand why the firm's stock price was falling as profits rose. Loren indicated that she had seen documents describing the firm's profit-
sharing plan under which all managers were partially compensated on the basis of the firm's profits. She suggested that maybe it was profit that was important to management because it directly affected their pay. Dale said, "That doesn't make sense, because the stockholders own the firm. Shouldn't management do what's best for stockholders? Something's wrong!" Loren responded, "Well, maybe that explains why the company hasn't concerned itself with the
stock price. Look, the only profits that stockholders receive are in the form of cash dividends, and this firm has never paid dividends during its 20-year history. We as stockholders therefore don't directly benefit from profits. The only way we benefit is for the stock price to rise." Dale chimed in, "That probably explains why the firm is being sued by state and federal environmental officials for dumping pollutants in the adjacent stream. Why spend money for pollution control? It increases costs, lowers profits, and therefore lowers management's earnings!"
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Loren and Dale realized that the lunch break had ended and they must quickly return to work. Before leaving, they decided to meet the next day to continue their discussion.
To Do
a.
What should the management of Sports Products, Inc., pursue as its overriding goal? Why?
a.
Maximization of shareholder
wealth, which means maximization of share
price, should be the primary goal of the firm.
b.
Unlike profit
maximization, maximization of shareholder wealth considers timing, cash
flows, and risk. It also reflects the worth of the
owners' investment in the firm at any time. It is the value they can realize should they decide to sell their shares.
b.
Does the firm appear to have an agency problem? Explain.
a.
Yes, there appears to be an agency problem. Although compensation for management is tied to
profits, it is not directly linked to share price.
b.
In
addition, management's actions with regard to pollution controls suggest a profit maximization
focus, which would maximize their
earnings, rather than an attempt to maximize share price
c.
Evaluate the firm's approach to pollution control. Does it seem to be ethical? Why might
incurring the expense to control pollution be in the best interests of the firm's owners despite its negative effect on profits?
a.
The
firm's approach to pollution control seems to be questionable ethically. While it is unclear whether their acts were intentional or
accidental, it is clear that they are violating the lawlong dash—an illegal act potentially leading to litigation costslong dash—and as a result are damaging the
environment, an immoral and unfair act that has potential negative consequences for society in general.
b.
Clearly, Sports Products has not only broken the law but also established poor standards of conduct and moral judgment.
d.
Does the firm appear to have an effective corporate governance structure? Explain any shortcomings.
a.
From the information given there appears to be a weak corporate governance system. The fact that management is able to measure and reward their performance on profits indicates that no one is watching out for the shareholders.
b.
Loren and
Dale's concerns indicate that employees apparently have an interest in the
long-run success of the firm. Allowing the continuation of pollution violations is also apparently escaping the interest and control ability of others who should be monitoring the firm.
e.
On the basis of the information provided, what specific recommendations would you offer the firm?
a.
Tie
management, and possibly
employee, compensation to share price or a performance-based measure and make sure that all involved own stock and have
a stake in the firm. Being compensated partially on the basis of share price or
another performance
measure, and owning stock in the firm will more closely link the wealth of managers and employees to the
firm's performance.
b.
Comply with all federal and state laws as well as accepted standards of conduct or moral judgment.
c.
Establish a corporate ethics
policy, to be read and signed by all employees.
d.
Set up a corporate governance system that has as its basis the oversight and welfare of all the stakeholders in the firm.
Cash Flow
It is typical for Jane to
plan,
monitor, and assess her financial position using cash flows over a given
period,
typically a month. Jane has a savings account and her bank loans money at 6% per year while it offers
short-term
investment rates of 5%. Jane's
cash flows during August were as
follows:
Item
Cash inflow
Cash outflow
Clothes
$1,300
Interest received
$450
Dining out
$460
Groceries
$830
Salary
$4,300
Auto payment
$346
Utilities
$270
Mortgage
$1,320
Gas
$244
a.
Determine Jane's total cash inflows and cash outflows.
$450 + $4,300 = $4,750
$1,300 + $460 + $830 + $346 + $270 + $1,320 + $244 = $4,770
b.
Determine the net cash flow
for the month of August.
$4,750 - $4,770 = $-20
c.
If there is a shortage, what are a few options open to Jane?
Jane can borrow money from her bank or withdraw money from an existing
savings/investing
account. Another alternative is to cut down on any unnecessary expenses
d.
If there is a surplus, what would be a prudent strategy for her to follow?
Jane can use her monthly surplus to open a
savings/investing
account or increase
the balance on an existing account.
Alternatively,
she could reduce debt by paying more for some obligations like her auto
loan,
credit cards or mortgage. In order to maintain her monthly surplus she should maintain her current level of expenses.
Corporate taxes
Tantor Supply, Inc., is a small corporation acting as the exclusive distributor of a major line of sporting goods. During 2021 the firm earned $748,900 before taxes.
a.
Calculate the firm's tax liability using a flat tax rate of 21%.
$748,900 x 21% = $157,269
b.
How much are Tantor Supply's 2021 after-tax earnings?
$748,900 - $157,269 = $591,631
c.
What was the firm's average tax rate?
Total amount of tax / total income
($157,269 / $748,900) = 21%
d.
What was the firm's marginal tax rate?
The marginal tax rate is the rate at which the last dollar of income is taxed. In this case, since the flat tax rate of 21% is used, the marginal tax rate is also 21%
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Marginal tax rates Using the tax rate schedule given below, perform the following:
Range of taxable income
Base tax
(Marginal
rate × amount over
base
bracket)
$0 to $9,875
$0 + (10% x amount over)
$0
9,876 to 40,125
988 + (12% x amount over)
$9,875
40,126 to 85,525
4,618 + (22% x amount over)
40,125
85,526 to 163,300
14,606 + (24% x amount over)
85,525
163,301 to 207,350
33,272 + (32% x amount over)
163,300
207,351 to 518,400
47,368 + (35% x amount over)
207,350
518,401 to Unlimited
156,235 + (37% x amount over)
518,400
a.
Find the marginal tax rate for the following levels of sole proprietorship earnings before taxes: a.
$16,700 = 12% Total tax liability for earnings before taxes of $16,700 = 1,807
988 + .12(16700 - 9876) = 1,807
b.
$58,300 = 22% Total tax liability for earnings before taxes of $16,700 = 8617
4,618 + .22(58,300 – 40,125) = 8617 c.
$91,900 = 24%
Total tax liability for earnings before taxes of $91,900 = 16,136
14,606 + .24(91,900 – 85,525) = 16,136
d.
$159,000 = 24%
Total tax liability for earnings before taxes of $159,000 = 32,240
14,606 + .24(159,000 – 85,525) = 32,240
e.
$250,000 = 35%
Total tax liability for earnings before taxes of $250,000 = 62,296
47,368 + .35(250,000 – 207,350) = 62,296
f.
$446,200 = 35%
Total tax liability for earnings before taxes of $446,200 = 130,966
47,368 + .35(446,200 – 207,350) = 130,966
g.
$1 million = 37%
Total tax liability for earnings before taxes of $1 million = 334,427
156,235 + .37(1,000,000 – 518,400) = 334,427
b. Plot the marginal tax rates (measured on the y-
axis) against the pretax income levels (measured on the x-
axis)
The relationship between these variables is that marginal tax rates increases as pretax incomes increase until the maximum rate of 37% is attained. The marginal tax rate actually increases in a
step-like
fashion as each tax bracket is
reached,
so the curve is not smooth.
Interest versus dividend expense
Michaels Corporation expects earnings before interest and taxes to be $52,000 for the current period. Assuming a flat ordinary tax rate of 21%, compute the firm's earnings after taxes and earnings available for common stockholders (earnings after taxes and preferred stock dividends, if any) under the following conditions:
a.
The firm pays $13,000 in interest.
Complete the fragment of Michaels
Corporation's
income statement below to compute the
firm's
earnings after taxes and earnings available for common stockholders under
condition
(
a
) (Round
to the nearest
dollar.)
Earnings Before Interest and Tax
$52,000
Less: Interest expense
$13,000
Earnings before taxes
$39,000
Less: Taxes (21%)
$8,190
Earnings after taxes
$30,810
Less: Preferred dividends
$0
Earning available for common stockholders
$30,810
b.
The firm pays $13,000 in preferred stock dividends.
EBIT
$52,000
Less: Interest expense
$0
Earnings before taxes
$52,000
Less: Taxes (21%)
$10,920
Earnings after taxes
$41,080
Less: Preferred dividends
13,000
Earning available for common stockholders
$28,080
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