EASY PROBLEMS 1-6

(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?

(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?

(2-3)

Molteni Motors Inc. recently reported $6 million of net income. Its EBIT was $13 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 $6 million net income by 1 T 0 6 to find the pre-tax income. The difference between EBIT and taxable income must be the interest expense. Use this procedure to work some of the other problems.)

(2-4)

Talbot Enterprises recently reported an EBITDA of $8 million and net income of $2.4 million. It had $2.0 million of interest expense, and its corporate tax rate was 40%. What was its charge for depreciation and amortization?

(2-5)

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.

(2-6)

In its most recent financial statements, Del-Castillo Inc. reported $70 million of net income and $900 million of retained earnings. The previous retained earnings were $855 million. How much in dividends did the firm pay to shareholders during the year?

INTERMEDIATE PROBLEMS 7-11

(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 is the firm's taxable income? What is it marginal tax rate? What is its tax expense? What is its after-tax income? What is the average tax rate based on taxable income?

(2-8)

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 additional 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 additional tax on this dividend income?

(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%. The 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.

(2-10)

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?

(2-11)

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 income? Its 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 changed the tax laws such that, instead of doubling Berndt's depreciation, it was reduced 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?

CHALLENGING PROBLEMS 12-13

(2-12)

Using Rhodes Corporation's financial statements (shown after Part f), answer the following questions.

a. What is the net operating profit after taxes (NOPAT) for 2016?

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 2016?

e. What is the ROIC for 2016?

f. How much of the FCF did Rhodes use for each of the following purposes: after- tax interest, net debt repayments, dividends, net stock repurchases, and net purchases of short-term investments? (Hint: Remember that a net use can be negative.)

(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 2016 the firm incurred a loss of $650,000. The firm will claim a tax credit at the time it files its 2016 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.

(2-14)

Begin with the partial model in the file Ch02 P14 Build a Model.xlsx on the textbook's Web site.

a. The 2016 sales of Cumberland Industries were $455,000,000; operating costs (excluding depreciation) were equal to 85% of sales; net fixed assets were $67,000,000; depreciation amounted to 10% of net fixed assets; interest expenses were $8,550,000; the state-plus-federal corporate tax rate was 40%; and Cumberland paid 25% of its net income out in dividends. Given this information, construct Cumberland's 2016 income statement. Also calculate total dividends and the addition to retained earnings. (Hint: Start with the partial model in the file and report all dollar figures in thousands to reduce clutter.)

b. The partial balance sheets of Cumberland Industries are shown here. Cumberland issued $10,000,000 of new common stock in 2016. Using this information and the results from Part a, fill in the missing values for common stock, retained earnings, total common equity, and total liabilities and equity.

c. Construct the statement of cash flows for 2016.

(2-15)

Build a Model: Free Cash Flows, EVA, and MVA resource Begin with the partial model in the file Ch02 P15 Build a Model.xlsx on the textbook's Web site.

a. Using the financial statements shown here for Lan & Chen Technologies, calculate net operating working capital, total net operating capital, net operating profit after taxes, free cash flow, and return on invested capital for 2016. (Hint: Start with the partial model in the file and report all dollar figures in thousands to reduce clutter.)

b. Assume there were 15 million shares outstanding at the end of 2016, the year-end closing stock price was $65 per share, and the after-tax cost of capital was 8%. Calculate EVA and MVA for 2016.

EASY PROBLEMS 1-6

(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?

(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?

(2-3)

Molteni Motors Inc. recently reported $6 million of net income. Its EBIT was $13 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 $6 million net income by 1 T 0 6 to find the pre-tax income. The difference between EBIT and taxable income must be the interest expense. Use this procedure to work some of the other problems.)

(2-4)

Talbot Enterprises recently reported an EBITDA of $8 million and net income of $2.4 million. It had $2.0 million of interest expense, and its corporate tax rate was 40%. What was its charge for depreciation and amortization?

(2-5)

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.

(2-6)

In its most recent financial statements, Del-Castillo Inc. reported $70 million of net income and $900 million of retained earnings. The previous retained earnings were $855 million. How much in dividends did the firm pay to shareholders during the year?

INTERMEDIATE PROBLEMS 7-11

(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 is the firm's taxable income? What is it marginal tax rate? What is its tax expense? What is its after-tax income? What is the average tax rate based on taxable income?

(2-8)

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 additional 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 additional tax on this dividend income?

(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%. The 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.

(2-10)

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?

(2-11)

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 income? Its 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 changed the tax laws such that, instead of doubling Berndt's depreciation, it was reduced 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?

CHALLENGING PROBLEMS 12-13

(2-12)

Using Rhodes Corporation's financial statements (shown after Part f), answer the following questions.

a. What is the net operating profit after taxes (NOPAT) for 2016?

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 2016?

e. What is the ROIC for 2016?

f. How much of the FCF did Rhodes use for each of the following purposes: after- tax interest, net debt repayments, dividends, net stock repurchases, and net purchases of short-term investments? (Hint: Remember that a net use can be negative.)

(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 2016 the firm incurred a loss of $650,000. The firm will claim a tax credit at the time it files its 2016 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.

(2-14)

Begin with the partial model in the file Ch02 P14 Build a Model.xlsx on the textbook's Web site.

a. The 2016 sales of Cumberland Industries were $455,000,000; operating costs (excluding depreciation) were equal to 85% of sales; net fixed assets were $67,000,000; depreciation amounted to 10% of net fixed assets; interest expenses were $8,550,000; the state-plus-federal corporate tax rate was 40%; and Cumberland paid 25% of its net income out in dividends. Given this information, construct Cumberland's 2016 income statement. Also calculate total dividends and the addition to retained earnings. (Hint: Start with the partial model in the file and report all dollar figures in thousands to reduce clutter.)

b. The partial balance sheets of Cumberland Industries are shown here. Cumberland issued $10,000,000 of new common stock in 2016. Using this information and the results from Part a, fill in the missing values for common stock, retained earnings, total common equity, and total liabilities and equity.

c. Construct the statement of cash flows for 2016.

(2-15)

Build a Model: Free Cash Flows, EVA, and MVA resource Begin with the partial model in the file Ch02 P15 Build a Model.xlsx on the textbook's Web site.

a. Using the financial statements shown here for Lan & Chen Technologies, calculate net operating working capital, total net operating capital, net operating profit after taxes, free cash flow, and return on invested capital for 2016. (Hint: Start with the partial model in the file and report all dollar figures in thousands to reduce clutter.)

b. Assume there were 15 million shares outstanding at the end of 2016, the year-end closing stock price was $65 per share, and the after-tax cost of capital was 8%. Calculate EVA and MVA for 2016.