# Following is targets 2011 income statement with the

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from the tax shield defined below). Following is Target's 2011 income statement with the operating items highlighted. Target's ting items include sales, cost of sales, SG&A, and depreciation expense. Target's pretax rating income is \$5,252 million. Its nonoperating activities relate to its borrowed money . y interest expense) which yield pretax net nonoperating expense of \$757 million. TARGET Incorrle Statement (\$ millions) For Year Ended January 29, 2011 Sales . Credit card revenues . Total revenues ..................................... •..•.. Cost of sales . Selling, general and administrative expenses . Credit card expenses . Depreciation and amortization . Earnings before interest expense and income taxes . Net interest expense Nonrecourse debt collateralized by credit card receivables . Other interest expense . Interest income .......... ............................... Net interest expense . Earnings before income taxes . Provision for income taxes . Net earnings . \$65,786 1,604 67,390 45,725 13,469 860 2,084 5,252 83 677 (3) 757 4,495 1,575 \$ 2,920 puting Tax on Operating Profit ::0 's income statement reports net operating profit before tax (NOPBT) of \$5,252 million. the numerator of the RNOA formula, defined previously, uses net operating profit after tax PAT).Thus, we need to subtract taxes to determine NOPAT. NOPAT = NOPBT - Tax on operating profit tax expense of \$1,575 million that Target reports on its income statement pertains to both ing and nonoperating activities. To compute NOPAT, we need to compute the tax expense g solely to operating profit as follows: on operating profit = Tax expense + (Pretax net nonoperating expense x Statutory tax rate) I I I Tax ~hield I amount in parentheses is called the tax shield, which is the taxes that Target saved by having -deductible nonoperating expenses (see Tax Shield box on the next page for details). By defini- the taxes saved (by the tax shield) do not relate to operating profits; thus, we must add back the shield to total tax expense to compute tax on operating profit. (For companies with nonoperating

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3-7 Module 3 I Profitability Analysis and Interpretation BUSINESS INSIGHT Tax Shield Persons with home mortgages understand well the beneficial effects of the "interest tax shield." To see how the interest tax shield works, consider two individuals, each with income of \$50,000 and each with only one expense: a home. Assume that one person pays \$10,000 per year in rent; the other pays \$10,000 in interest on a home mortgage. Rent is not deductible for tax purposes, whereas mortgage interest (but not principal) is deductible. Assume that each person pays taxes at 25%, the personal tax rate for this income level. Their tax payments follow. \$50,000 o \$50,000 \$12,500 \$50,000 (10,000) \$40,000 \$10,000 Income before interest and taxes . Less interest deduction . Taxable income . Taxes paid (25% rate) . The renter reports \$50,000 in taxable income and pays \$12,500 in taxes. The home owner deducts \$10,000 in interest, which lowers taxable income to \$40,000 and reduces taxes to \$10,000. By deduct- ing mortgage interest, the home owner's tax bill is \$2,500 lower. The \$2,500 is the interest tax shield, and we can compute it directly as the \$10,000 interest deduction multiplied by the 25% tax rate.
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