ADMS 3541 Lecture Notes - Lecture 4: Tax Rate, Ordinary Income
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Instructions: Use the formula below to compute the problems: “Please Read the question carefully.”
Kd = Yield (1 – T)
1. Telecom Systems can issue debt yielding 8 percent. The company is in a 35 percent bracket. What is its after-tax cost of debt?
2. After-tax cost of debt: Royal Jewelers Inc., has an aftertax cost of debt of 6 percent. With a tax rate of 40 percent, what can you assume the yield on the debt is?
3.
Cash flow: Assume a corporation has earnings before depreciation and taxes of $100,000, depreciation of $50,000, and that it has a 30 percent tax bracket. Compute its cash flow using the format below.
Earnings before depreciation and taxes _____
Depreciation _____
Earnings before taxes _____
Taxes @ 30% _____
Earnings after taxes _____
Depreciation _____
4.
Cost of preferred stock: Medco Corporation can sell preferred stock for $80 with an estimated flotation cost of $3. It is anticipated the preferred stock will pay $6 per share in dividends.
a. Compute the cost of preferred stock for Medco Corp.
b. Do we need to make a tax adjustment for the issuing firm?
5. Cost of preferred stock: The Meredith Corporation issued $100 par value preferred stock 10 years ago. The stock provided an 8 percent yield at the time of issue. The preferred stock is now selling for $75. What is the current yield or cost of the preferred stock? (Disregard flotation costs.)
6. Costs of retained earnings and new common stock: Barton Electronics wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $1.20 per share, and the current price of its common stock is $30 per share. The expected growth rate is 9 percent.
a. Compute the cost of retained earnings (Ke). Use Formula 11-6.
b. If a $2 flotation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-7.
7. A firm's cost of preferred stock is equal to the preferred dividend divided by market price plus the dividend growth rate (Kp= D/Po+ g).
8. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.
a. True
b. False
9. The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.
a. True
b. False
10. The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.
a. True
b. False
11. You have the following data on three stocks:
Stock | Standard Deviation | Beta |
A | 20% | 0.59 |
B | 10% | 0.61 |
C | 12% | 1.29 |
If you are a strict risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio.
a. A; A.
b. A; B.
c. B; A.
d. C; A.
e. C; B.
12. A portfolio’s risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
a. True
b. False
13. You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?
a. The price of Bond B will decrease over time, but the price of Bond A will increase over time.
b. The prices of both bonds will remain unchanged.
c. The price of Bond A will decrease over time, but the price of Bond B will increase over time.
d. The prices of both bonds will increase by 7% per year.
e. The prices of both bonds will increase over time, but the price of Bond A will increase at a faster rate.
14. A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?
a. If market interest rates decline, the price of the bond will also decline.
b. The bond is currently selling at a price below its par value.
c. If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today.
d. The bond should currently be selling at its par value.
e. If market interest rates remain unchanged, the bond’s price one year from now will be higher than it is today.
15. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 5.14%
b. 5.42%
c. 5.70%
d. 5.99%
e. 6.28%
16. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 3.80%
b. 3.99%
c. 4.19%
d. 4.40%
e. 4.62%
17. Assume that interest rates on 20-year Treasury and corporate bonds are as follows:
T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%
The differences in these rates were probably caused primarily by:
a. Tax effects.
b. Default and liquidity risk differences.
c. Maturity risk differences.
d. Inflation differences.
e. Real risk-free rate differences.
18. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?
a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
b. The discount rate increases.
c. The riskiness of the investment’s cash flows decreases.
d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
e. The discount rate decreases.
19. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?
a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
b. If the pure expectations theory holds, the corporate yield curve must be downward sloping.
c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.
d. If inflation is expected to decline, there can be no maturity risk premium.
e. The expectations theory cannot hold if inflation is decreasing.
20. Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
a. True
b. False
I know it's a lot but they are all small questions related to the same case so I didn't know how to split it into multiple questions. I would really appreciate the help, as I need a way to compare my answers.
Dallas & Associates Financial Statement Preparation & Analysis
You have been hired as a senior financial analyst for Dallas and Associates and you are in charge of preparing the financial statements and presenting an annual analysis at the board meeting.
Overview of Dallas & Associate’s Balance Sheet
The assets of Dallas & Associates in 2017 have both current assets and net plant and equipment. It has total assets of $ 7.5 million and net plan and equipment equals $5 million. Dallas & Associate’s only finances with $2.5 million long-term debt, $500,000 notes payable and total common equity of $3.5 million. The firm does have $400,000 accounts payable and $600,000 accruals on its balance sheet. Now assume the firm’s current assets consist entirely of cash and cash equivalence, account receivables and inventories. If it has 1.5 million cash and cash equivalents and $400,000 account receivables.
Dallas & Associates Income Statement in 2017 (dollars are in millions)
Sales | 15 |
Operating costs excluding depreciation and amortization | 5 |
EBITDA | 10 |
Depreciation & Amortization | 0.6 |
EBIT | 9.4 |
Interest | 0.4 |
EBT | 9 |
Taxes (40%) | 3.6 |
Net Income Cash Dividends | 5.4 2.0 |
Use the above information to answer the following questions. Make sure to include the calculation steps/ formula.
Questions:
a. Prepare the balance sheet.
Total Assets | Liabilities & Shareholder’s Equity |
b. What is the amount of total liabilities and equity that appears on the firm’s balance?
c. What is the amount of current assets?
d. What is the balance of current liabilities?
e. What is the amount of company’s inventory?
f. What is the amount of total liabilities?
g. What is the amount of total debt?
h. What is the amount of total capital?
i. What is the amount of net working capital?
j. What is the amount of net operating working capital?
k. If by the end of 2017, the retained earnings of John and Jon is $2.5 million, what is the amount of paid-in capital?
l. If John & Jon decides to purchase $500,000 market securities by using its cash, how does this action would affect its current asset position?
m. As the Income of Statement shows in 2017 John & Jon actually gave out $2 million cash dividends, what is the amount of retained earnings?
n. What is the amount of operating income?
o. What are the operating margin and the profit margin?
p. What is the average length of time that John & Jon must wait after making a sale before it receives cash?
q. What is the ratio we generally use to estimate a firm’s ability to meet its annual interest payments? And calculate that ratio for John and Jon.
r. What are the fixed assets turnover ratio and the total asset turnover ratio?
s. What is the ratio of total debt to total capital?
t. What is the ratio of return on common equity?
u. Assume between 2016 and 2017, net operating working capital has increased by $500,000, calculate John & Jon’s free cash flow. (Hint: use this formula. FCF = [EBIT (1-T) +Depreciation & Amortization] – [Capital Expenditures + Change on Net Operating Working Capital])
v. Now after you present your analysis on the meeting, the CEO would like to see higher sales and a forecasted net income of $10.8 million. Assume that operating costs (excluding depreciation and amortization) are still one third of sales and that depreciation and amortization and interest expenses will increase by 10%. The tax rate which is 40%, will remain the same. What level of sales would generate $10.8 million in net income?
THANK YOU!
I need Answers to Question from P - V!
I know it's a lot but they are all small questions related to the same case so I didn't know how to split it into multiple questions. I would really appreciate the help, as I need a way to compare my answers.
Dallas & Associates Financial Statement Preparation & Analysis
You have been hired as a senior financial analyst for Dallas and Associates and you are in charge of preparing the financial statements and presenting an annual analysis at the board meeting.
Overview of Dallas & Associate’s Balance Sheet
The assets of Dallas & Associates in 2017 have both current assets and net plant and equipment. It has total assets of $ 7.5 million and net plan and equipment equals $5 million. Dallas & Associate’s only finances with $2.5 million long-term debt, $500,000 notes payable and total common equity of $3.5 million. The firm does have $400,000 accounts payable and $600,000 accruals on its balance sheet. Now assume the firm’s current assets consist entirely of cash and cash equivalence, account receivables and inventories. If it has 1.5 million cash and cash equivalents and $400,000 account receivables.
Dallas & Associates Income Statement in 2017 (dollars are in millions)
Sales | 15 |
Operating costs excluding depreciation and amortization | 5 |
EBITDA | 10 |
Depreciation & Amortization | 0.6 |
EBIT | 9.4 |
Interest | 0.4 |
EBT | 9 |
Taxes (40%) | 3.6 |
Net Income Cash Dividends | 5.4 2.0 |
Use the above information to answer the following questions. Make sure to include the calculation steps/ formula.
Questions:
a. Prepare the balance sheet.
Total Assets | Liabilities & Shareholder’s Equity |
b. What is the amount of total liabilities and equity that appears on the firm’s balance?
c. What is the amount of current assets?
d. What is the balance of current liabilities?
e. What is the amount of company’s inventory?
f. What is the amount of total liabilities?
g. What is the amount of total debt?
h. What is the amount of total capital?
i. What is the amount of net working capital?
j. What is the amount of net operating working capital?
k. If by the end of 2017, the retained earnings of John and Jon is $2.5 million, what is the amount of paid-in capital?
l. If John & Jon decides to purchase $500,000 market securities by using its cash, how does this action would affect its current asset position?
m. As the Income of Statement shows in 2017 Dallas associates actually gave out $2 million cash dividends, what is the amount of retained earnings?
n. What is the amount of operating income?
o. What are the operating margin and the profit margin?
p. What is the average length of time that Dallas associates must wait after making a sale before it receives cash?
q. What is the ratio we generally use to estimate a firm’s ability to meet its annual interest payments? And calculate that ratio for Dallas associates.
r. What are the fixed assets turnover ratio and the total asset turnover ratio?
s. What is the ratio of total debt to total capital?
t. What is the ratio of return on common equity?
u. Assume between 2016 and 2017, net operating working capital has increased by $500,000, calculate Dallas & Associates free cash flow. (Hint: use this formula. FCF = [EBIT (1-T) +Depreciation & Amortization] – [Capital Expenditures + Change on Net Operating Working Capital])
v. Now after you present your analysis on the meeting, the CEO would like to see higher sales and a forecasted net income of $10.8 million. Assume that operating costs (excluding depreciation and amortization) are still one third of sales and that depreciation and amortization and interest expenses will increase by 10%. The tax rate which is 40%, will remain the same. What level of sales would generate $10.8 million in net income?
THANK YOU!