An investor recently purchased a corporate bond
Chapter 3 How to
Reviewing Chapter 3 – Financial statement
Reviewing Ch3 – FM
3-1
An investor recently purchased a corporate bond which yields 9%. The investor is in the 36% combined federal and state tax bracket. What is the bond’s after-tax yield?
3-2
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?
3-3
Little Books Inc. recently reported $3 million of net income. Its EBIT was $6 million, and its tax rate was 40%. What was its interest expense? [Hint: Write out the headings for an income statement and then fill in the known values. Then divide $3 million net income by (1–T) [1] 0.6 to find the pre-tax income. The difference between EBIT and taxable income must be the interest expense. Use this same procedure to work some of the other problems.]
3-4
Pearson Brothers recently reported an EBITDA of $7.5 million and net income of $1.8 million. It had $2.0 million of interest expense, and its corporate tax rate was 40%. What was its charge for depreciation and amortization?
3-5
Kendall Corners Inc. recently reported net income of $3.1 million and depreciation of $500,000. What was its net cash flow? Assume it had no amortization expense.
3-6
In its most recent financial statements, Newhouse Inc. reported $50 million of net income and $810 million of retained earnings. The previous retained earnings were $780 million. How much in dividends was paid to shareholders during the year?
3-7
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?
The firm’s income tax liability?
3-8
The Wendt Corporation had $10.5 million of taxable income.
a. What is the company’s federal income tax bill for the year?
b. Assume the firm receives an additional $1 million of interest income from some bonds it owns. What is the tax on this interest income?
c. Now assume that Wendt does not receive the interest income but does receive an additional $1 million as dividends on some stock it owns. What is the tax on this dividend income?
3-9
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 munibonds, which yield 5%, 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 returns on both securities.
3-10
The Moore Corporation has operating income (EBIT) of $750,000. The company’s depreciation expense is $200,000. Moore is 100% equity financed, and it faces a 40% tax rate. What is the company’s net income? What is its net cash flow?
3-11
The Berndt Corporation expects to have sales of $12 million. Costs other than depreciation are expected to be 75% of sales, and depreciation is expected to be $1.5 million. All sales revenues will be collected in cash, and costs other than depreciation must be paid for during the year. Berndt’s federal-plus-state tax rate is 40%. Berndt has no debt.
a. Set up an income statement. What is Berndt’s expected net cash flow?
b. Suppose Congress changed the tax laws so that Berndt’s depreciation expenses doubled. No changes in operations occurred. What would happen to reported profit and to net cash flow?
c. Now suppose that Congress, instead of doubling Berndt’s depreciation, reduced it by 50%. How would profit and net cash flow be affected?
d. If this were your company, would you prefer Congress to cause your depreciation expense to be doubled or halved? Why?
3-12
You have just obtained financial information for the past 2 years for Bridgewater Equine Corporation. Answer the following questions.
a. What is the net operating profit after taxes (NOPAT) for 2007?
b. What are the amounts of net operating working capital for both years?
c. What are the amounts of total net operating capital for both years?
d. What is the free cash flow for 2007?
e. How can you explain the large increase in dividends in 2007?
Bridgewater Equine Corporation: Income Statements for Year Ending
December 31 (Millions of Dollars)
2007 2006
Sales $1,200.0 $1,000.0
Operating costs excluding depreciation 1,020.0 850.0
Depreciation 30.0 25.0
Earnings before interest and taxes $ 150.0 $ 125.0
Less interest 21.7 20.2
Earnings before taxes $ 128.3 $ 104.8
Taxes (40%) 51.3 41.9
Net income available to common stockholders $ 77.0 $ 62.9
Common dividends $ 60.5 $ 4.4
Assets
Cash and equivalents $ 12.0 $ 10.0
Short-term investments 0.0 0.0
Accounts receivable 180.0 150.0
Inventories 180.0 200.0
Total current assets $372.0 $360.0
Net plant and equipment 300.0 250.0
Total assets $672.0 $610.0
Liabilities and Equity
Accounts payable $108.0 $90.0
Notes payable 67.0 51.5
Accruals 72.0 60.0
Total current liabilities $247.0 $201.5
Long-term bonds 150.0 150.0
Total liabilities $397.0 $351.5
Common stock (50 million shares) 50.0 50.0
Retained earnings 225.0 208.5
Common equity $275.0 $258.5
Total liabilities and equity $672.0 $610.0
