FIN 300 - Fin Ratios 4
Marginal Tax Rates $1M x 0.10 = $0.1M + $2M x 0.20 = $0.4M + $3M x 0.30 = $0.9M + $2M x 0.40 = $0.8M = $2.2M tax to be paid! FIN 300 - Fin Ratios 5
Average Tax Rate • Using the previous info, what is the “average” tax rate paid by the firm? • Answer: Divide the $2.2M in taxes by the $8M in taxable income Average Tax Rate = $2.2M/$8M = 0.275 = 27.5% FIN 300 - Fin Ratios 6
Retained Earnings Calculations When a firm earns net income (available to common, that is), the net income (or, earnings) goes 1 of 2 places: 1) Either to pay (common) dividends 2) Or, back on the balance sheet, added to the previous year’s “retained earnings” FIN 300 - Fin Ratios 7
Retained Earnings Calculations Example: Given…… • Previous year’s (balance sheet) retained earnings = $5M • This year’s net income is $2M • Dividends paid this year in the amount of $500k What are the retained earnings on the balance sheet at the end of the current year? FIN 300 - Fin Ratios 8
Retained Earnings Calculation Net Income = Dividends + Chg. in Ret. Earn (RE) Net Income = Dividends + (New RE – Old RE) $2M = $0.5M + New RE - $5M $2M - $0.5M + $5M = New RE $6.5M = New RE! FIN 300 - Fin Ratios 9
Retained Earnings Calculations Another example: Given: NI = -$3M, Dividends = $1M, New RE = -$6M What must have been the old (last year’s) RE on the balance sheet? FIN 300 - Fin Ratios 10
Retained Earnings Calculations NI = -$3M, Dividends = $1M, New RE = -$6M NI = Dividends + (New RE – Old RE) -$3M = $1M - $6M – Old RE $2M = - Old RE Old RE = -$2M! FIN 300 - Fin Ratios 11
Retained Earnings Calculations A few points…. • Dividends are always zero or positive (there is no such thing as a negative dividend) • However, earnings (NI, that is) and RE (on the balance sheet) may be negative • Yes, dividends may be paid in an amount greater than net Income and dividends may be paid, even when net income is negative! FIN 300 - Fin Ratios 12
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