FIN 612 Managerial Finance

Week Two Assignment

Suzan Sbeih

Chapter 2 Problems

2-1) An investor recently purchased a corporate bond that yields 9%. The investor is in the
36% combined federal and state tax bracket. What is the bond’s after-tax yield?
We have 9% pretax yield X 36% combined taxes =
.09x.36=.0324 (3%)
.09-.0324=.0576 (6%)
The after tax yield= %6

2-2) Corporate bonds issued by Johnson Corporation currently yield 8%. Municipal bonds of
equal risk currently yield 6%. At what tax rate would an investor be indifferent between these
two bonds?
After Tax Yield (ATy) = (Before tax yield, BTy)(1-T)
(8%)(1-T) = (6%)(1-0) = 6%
(.08(1-T) = .06
.08 - .08T = .06
-.08T = .06-.08
-.08T = -.02
T = .02/.08 = 25%

2-7) The Talley Corporation had a taxable income of $365,000 from operations after all
operating costs but before (1) interest charges of $50,000, (2) dividends received of $15,000, (3)
dividends paid of $25,000, and (4) income taxes. What are the firm’s income tax liability and its
after-tax income? What are the company’s marginal and average tax rates on taxable income?

Income $365,000
Less Interest deduction (50,000)
Plus: Dividends received 4,500
Taxable income $319,500
70% of dividends received are excluded from taxes = $15,000(1 - 0.70) = $4,500.

Tax = $22,250 + ($319,500 - $100,000)*0.39

Tax= $22,250 + $85,605 = $107,855.

After-tax income:
Taxable income $319,500
Taxes (107,855)
Plus Non-taxable dividends received 10,500
Net income $222,145
Non-taxable dividends: $15,000 x 0.7 = $10,500.

Marginal tax rate is 39 percent

Average tax rate is $107,855/$319,500 = 33.76%.
2-9) The Shrieves Corporation has $10,000 that it plans to invest in marketable securities. It is
choosing among AT&T bonds, which yield 7.5%, state of Florida muni bonds, which yield 5%
(but are not taxable), and AT&T preferred stock, with a dividend yield of 6%. Shrieves’s
corporate tax rate is 35%, and 70% of the dividends received are tax exempt. Find the after-tax
rates of return on all three securities.
Bond AT&T = 7.5% (Before tax yields)
Flor. Muni = 5%
T = .35
AT&T Pref. Stock = 6% (70% tax exempt)
ATY = (Before tax yield)(1 – T)
ATT Bond = (7.5%)(1 - .35)
= (7.5)(.65)
= 4.88% ATY
Flor. Muni = (5%)(1 – 0) = 5%
Pref. Stock = (6%)[1-(.3)(.35)]
= (6%)(1 - .105)
= (6%)(.895)
= 5.37% - Highest after tax yield from preferred stock

2-13) The Bookbinder Company has made $150,000 before taxes during each of the last 15
years, and it expects to make $150,000 a year before taxes in the future. However, in 2013 the
firm incurred a loss of $650,000. The firm will claim a tax credit at the time it files its 2013
income tax return, and it will receive a check from the U.S. Treasury. Show how it calculates this
credit, and then indicate the firm’s tax liability for each of the next 5 years. Assume a 40% tax
rate on all income to ease the calculations.

Through use of a loss carry back, a company may carry the net operating loss back two years and
receive refunds for income taxes paid in those years
So if we loss carry back for Prior Years 2011 and 2012
On profit 2011 we calculate tax of 40% (150000x40%) = 60000
On profit 2012 we calculate tax of 40% (150000x40%) = 60000

Total 120,000 is deducted from the 2013 loss of 650,000= 530,000

The remaining 530,000 we can carry forward (As per tax rules we can carry forward loss up to
20 years)

If we carry forward the loss of 530,000 to redeem completely it will take 6.3years if every year
we redeem 60000
If we carry forward the amount we will not pay any tax for next 6.3 years
So the Firm's tax liability is zero for next 6.3years
So for 2014,15,16,17,18 the Firm's tax liability is zero
1) Prepare an ending 1998 Income Statement and Balance Sheet from the following
information: Sales $800,000; Cost of Goods Sold $300,000; Accounts Receivables $20,000;
Bonds Outstanding $160,000; Accounts Payable $20,000; Advertising Expense $1,000;
Administrative Expenses $35,000; Interest Expense $24,000; Depreciation Expense $40,000;
Dividends Paid $137,000; Rent Expense $5,000; Accruals $20,000; Common Stock $100,000;
Retained Earnings $245,000 (Beginning 0f 1998); Cash $20,000; Inventory $45,000; Net Fixed
Assets $600,000 (Beginning of 1998). (Assume a 40% Tax Rate)

Balance Sheet
(In Millions)

Jan. 1 Dec. 31 Source Use

ASSETS

Cash $25 $20 _____ _____

Mkt. Sec. 30 22 _____ _____
Accounts Rec. 50 60 _____ _____
Inventory 120 150 _____ _____
Total Curr. Assets $225 $252 _____ _____

Gross Fixed Assets $155 $170 _____ _____

Less: Accum. Dep. (47) (55) _____ _____
Net Fixed Assets $108 $115 _____ _____

Total Assets $333 $367

LIABILITIES

Accounts Payable $41 $35 _____ _____

Notes Payable 30 15 _____ _____
Other Liabilities 19 35 _____ _____
Long Term Debt 21 25 _____ _____
Total Liabilities $111 $110

OWNERS EQUITY

Common Stock $83 $83 _____ _____

Retained Earnings 139 174 _____ _____
Total Equity $222 $257

Total Liability & OE $333 $367

During the year the (XYZ company) purchased an additional $15million worth of fixed assets.
The charge for depreciation in 2000 was $8 million. In addition, earnings after tax amounted to
70 million, and the company paid out 35 million in dividends
 Income Statement
XYZ Company
Jan1-Dec 31 1998

Revenue Net sales

Cost of goods
Gross profit
Operating expenses Advertising
Insurance
Payroll
Supplies
Utilities
Operating income
Additional Income Other revenue
Other expenses
Net income