# Corp2022fch4ndoc 19 the high debt case aftertax

• 42

This preview shows page 19 - 23 out of 42 pages.

Corp2022F_Ch4n.doc19The High-debt case:Aftertax operating income(1) = Net income + Interest - Interest tax shield= 9,100 + 2,000 - 2,000 × 0.35 = 10,400(2) = Net income + after-tax interests= 9,100 + 2,000 × (1-0.35) = 10,400- a formal proof:Aftertax operating income of the firm= Net income + Interest - Interest tax shield= (EBIT - Interests - Tax) + Interest - Interest tax shield= EBIT - Tax - Interest tax shield= EBIT - (EBIT - Interest) × TC- Interest × TC= EBIT - EBIT × TC+ Interest × TC- Interest × TC= EBIT - EBIT × TC= EBIT × (1-TC)Note:It shows that the aftertax operating income of the firm is independent ofthe firm's financial policy (i.e., the use of debt)Accounting Rates of Return- EVA: a dollar measuresubject to the scale of the firm"profits per dollarof assets"- a digression:Excess measure = observed measure - benchmark measureExcess return = observed return - benchmark return
Corp2022F_Ch4n.doc201. Return on Capital (ROC)%0.17520,21658,3tioncapitalizatotalincomeoperatingaftertaxROC%4.97.6%-17.0%capitalofcost-%0.17returnExcess%4.29%6.70.17capitalof%costcapitalof%costtioncapitalizatotalincomeoperatingaftertaxtioncapitalizatotaltioncapitalizaTotalcapitalof%cost-incomeoperatingaftertaxtioncapitalizatotalEVAROCROC based on another measure of total capitalization:%4.162/)172,233520,21(658,3tioncapitalizatotalaverageincomeoperatingaftertaxROCTotal cap. in 2019New cap. during 2020Total cap. in 2020Operating income in202020192020
Corp2022F_Ch4n.doc21Table 4.4: EVA & ROC of some firms in June 2013Note: Operating income = Net income + aftertax interestssome observations based on Table 4.41. Operating income does not take into account the cost of capital2. EVA recognizes that companies need to cover their opportunitycosts before they add value3. EVA (or ROC) is a better measure of a company's performance thanoperating income4. EVA and ROC are not comparable across firms, but "Excess return"of Column 6 is.2. Return On Assets (ROA)it measures aftertax operating income as a fraction of the firm'stotalassetsTotal assets = total liabilities + shareholders' equitytotal assets >= total capitalization%9.8920,41658,3assetstotalincomeoperatingaftertaxassetsonReturnROA based on another measure of total capitalization:%7.82/)779,42920,41(658,3assetstotalaverageincomeoperatingaftertaxassetsonReturnTotal assetsin 2019Adding new assets during 2020Total assets in 2020Operating income in202020192020
Corp2022F_Ch4n.doc22- a caveat:assetstotalincomeoperatingaftertaxROAversusa s s e tt o t a li n c o m en e tNIROATotal Assets: 96,000Aftertax operating income = 10,400Low-debtNo-debtHigh-debtROA10.833%10.833%10.833%NIROA10.292%10.833%9.479%2. Return on Equity (ROE)it is the income to shareholders per dollar that they have invested%0.29297,11281,3equityincomenetROEequityonReturn%4.282/)833,11297,11(281,3equityaverageincomenetROEequityonReturnDebt usageLowNoHighRevenues760007600076000- Costs430004300043000-Other administrative expenses150001500015000- Depreciation and Amortization200020002000Operating Income (EBIT)160001600016000- Interests80002000Taxable income152001600014000- Taxes (35%)532056004900Net Income9880104009100

Course Hero member to access this document

Course Hero member to access this document

End of preview. Want to read all 42 pages?

Course Hero member to access this document

Term
Spring
Professor
NoProfessor
Tags
COGS