Ch7-HW - 7—3 SOLUTIONS TO END—OF-CHAPTER PROBLEMS...

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Unformatted text preview: 7—3 SOLUTIONS TO END—OF-CHAPTER PROBLEMS Corporate yield = 9%; T = 35.5% AT yield = 9%(1 — T) = 9%(0.645) = 5.76% Corporate bond yields 8%. Municipal bond yields 6%. Equivalent pretax yield ~ Yield on muni ‘ (1 — T) 6% (1— T) 0.08 ~ 0.08T = 0.06 — 0.08T = —0.02 T = 25%. on taxable bond 8%: Income $365,000 Less Interest deduction (50,000) Plus: Dividends received21 4,500 Taxable income $3 19,5 00 61For a corporation, 70% of dividends received are excluded from taxes; therefore, taxable dividends are calculated as $15,000(1 - 0.70) = $4,500. Tax = $22,250 + ($319,500 — $100,000)(0.39) = $22,250 + $85,605 = $107,855. After—tax income: Taxable income $319,500 Taxes (107,855) Plus Non-taxable dividends receivedb 10,5 00 Net income $2222 145 bNon-taxable dividends are calculated as $15,000 x 0.7 = $10,500. The company’s marginal tax rate is 39 percent. The company’s average taxrate is $107,855/$319,500 = 33.76%. Answers and Solutions: 7- 7 7-4 a. Tax = $3,400,000 + ($10,500,000 - $10,000,000)(0.35) = $3,575,000. b. Tax = $1,000,000(0.35) = $350,000. c. Tax = ($1,000,000)0.30(0.35) = $105,000. 7—5 A—T yield on FLA bond = 5%. A-T yield on AT&T bond = 7.5% - Taxes = 7.5% — 7.5%(0.35) = 4.875%. Check: Invest $10,000 @ 7.5% = $750 interest. Pay 35% tax, so A-T income = $750(l — T) = $750(0.65) = $487.50. A—T rate ofreturn = $487.50/$10,000 =4.875%. A—T yield on AT&T preferred stock: A—T yield = 6% - Taxes = 6% — O.3(6%)(0.35) = 6% — 0.63% = 5.37%. Therefore, invest in AT&T preferred stock. We could make this a harder problem by asking for the tax rate that would cause the company to prefer the Florida bond or the AT&T bond. EBIT = $750,000; DEP = $200,000; 100% Equity; T = 40% NI=?;NCF=?;OCF=? ' First, determine net income by setting up an income statement: EBIT $750,000 Interest 0 EBT $75 0,000 Taxes (40%) 300,000 NI $450,000 ' NCF = N1 + DEP = $450,000 + $200,000 = $650,000. Answers and Solutions: 7 - 8 b. Income Statement , a: Sales revenues $12,000,000 Costs except depreciation 9,000,000 Depreciation 1,500,000 EBT $ 1,500,000 Taxes (40%) 600,000 Net income $ 900,000 Add back depreciation 1,500,000 Net cash flow § 2,400,000 If depreciation doubled, taxable income would fall to zero and taxes would be zero. ihus, net-mcome--WQMLQQQQS§£0 zero but net cash flow wou Ese‘tdEB’EUUDOO. _ mm, _ N . , _—‘._ —« Menen‘dez would save $600,000 in taxes, thus increasing 1ts cash flow: ACF = T(ADepreciation) = 0.4($l,500,000) = $600,000. If depreciation were halved, taxable income would rise to $2,250,000 and taxes to $900,000. Therefore, net income would rise to $1,350,000, but net cash flow would N fall to $2,100,000,» ~ You should prefer to have higher depreciation charges and higher cash flows. Net cash flows are the funds that are available to the owners to withdraw from the firm and, therefore, cash flows should be more important to them than net income. , Answers and Solutions: 7— 9 7—8 a. NOPAT = EBIT(1 — Tax rate) = $150,000,000(0.6) = $90,000,000. b. NOWCos = Operating CA — operating CL = $360,000,000 - ($90,000,000 + $60,000,000) = $210,000,000. * <35», NOWC06 = $372,000,000 - $180,000,000 = $192,000,000. , , Net plant Net operating 0. Operating capitalos = . + . . and equipment working capital = $250,000,000 + $210,000,000 = 0,000,009 Operating capitalos = $300,000,000 + $192,000,000 = $492,000,000. d. F CF = NOPAT - Net investment 1n operatm capital = $90,000,000 - ($492,000,000 — $460,000,000) =58 000 002,, ‘ e. The large increase in dividends for 2006 can most likely be attributed to a large increase in free cash flow from 2005 to 2006, since FCF represents the amount of cash available to be paid out to stockholders after the company has made all investments in fixed assets and working capital necessary to sustain the business. fl Answers and Solutions: 7 — 10 ...
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Ch7-HW - 7—3 SOLUTIONS TO END—OF-CHAPTER PROBLEMS...

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