Question 1

Silver Photo Studios Inc.(SPS)requires $50,000 capital for a proposed expansion.Simon Silver,the company's president and CEO is trying to decide whether to issue preferred shares with a fixed dividend rate of 5%,or to borrow from the bank at a rate of 7%.SPS pays a corporate tax rate of 15%.
Required:

A)Determine the amount of corporate income that would be required for each of the alternative funding methods.
B)Calculate the actual cost (as a %)of the debt and the actual cost (as a %)of issuing the preferred shares.

A)Corporate income of $3,500 ($50,000 × 7%)is required to finance the interest on the bank loan.
Corporate income of $2,941 ($50,000 × 5%)/(1 - .15)is required to finance the dividends on the preferred shares.
B)The cost of the 7% debt is 7%.(3,500/50,000)
The cost of the 5% dividend is 5.9%.(2,941/50,000)

Accepted Answer

A)Corporate income of $3,500 ($50,000 &#215; 7%)is required to finance the interest on the bank loan.&#10;Corporate income of $2,941 ($50,000 &#215; 5%)/(1 - .15)is required to finance the dividends on the preferred shares.&#10;B)The cost of the 7% debt is 7%.(3,500/50,000)&#10;The cost of the 5% dividend is 5.9%.(2,941/50,000)

Question 2

Andrea Houser recently inherited $500,000.She would like to invest the money and receive an after-tax return of $30,000 on the investment income.She has a number of investment alternatives available to her and she would pay 45% tax on interest,28% tax on eligible dividends,35% tax on non-eligible dividends,and 23% (rounded)on capital gains.
Required:
Advise Andrea as to how much taxable income she would need to receive in a)interest,b)eligible dividends,c)non-eligible dividends,and d)capital gains in order to realize a $30,000 after-tax return.(Round all answers to zero decimal points.)

Accepted Answer

11ea6d24_5f79_f60b_b3c7_43e5173760a1_TB1840_00

Question 3

Joe Genius of ABC Corporation is considering whether to lease or purchase a large capital asset.If he purchases the asset,he will use debt financing.Which of the following is a true statement describing a similarity in the tax treatment of leasing and purchasing with debt?

A) Both allow for a tax deduction.
B) Principal payments are deductible for both alternatives.
C) Cash payments and tax savings will usually occur simultaneously for both alternatives.
D) Capital cost allowance is always calculated for both alternatives.

A

Accepted Answer

Both leasing and purchasing with debt allow for a tax deduction. For leasing, the lease payments are considered a business expense and are therefore tax-deductible. For purchasing with debt, the interest payments on the debt are tax-deductible. However, principal payments are not tax-deductible in either case. Option B is incorrect as principal payments are not tax-deductible. Option C is not always true as the timing of cash payments and tax savings may differ depending on the specific terms of the lease or debt financing. Option D is not true as capital cost allowance only applies to purchasing and not leasing.

Question 4

With regard to debt securities,which of the following statements is true?&#10;A) Issuing debt securities at a premium is not allowed for tax purposes.&#10;B) Issuing debt securities at a premium results in the borrowing corporation receiving funds below the stated price.&#10;C) Issuing debt securities at a premium will normally increase the after-tax cost of financing for the issuer, provided they are not in the business of lending money.&#10;D) Issuing debt securities at a premium will normally reduce the after-tax cost of financing for the issuer, provided they are not in the business of lending money.

Accepted Answer

Issuing debt securities at a premium means the issuer receives more funds than the face value, which can reduce the after-tax cost of financing as the premium amortization is tax-deductible.

Question 5

Mary is deciding where to invest $10,000.Based on her decision,she will either receive a 5% capital gain or a 7% non-eligible dividend as her return on investment.Mary's marginal tax rates are: 45% on regular income,35% on non-eligible dividends,28% on eligible dividends,and 23% (rounded)on capital gains.Which of the following is correct?

A) Mary will receive a higher after-tax rate of return on the capital gain due to the higher tax rate for non-eligible dividends.
B) Mary will receive an after-tax rate of return of 5% on the capital gain and 7% on the non-eligible dividends.
C) Mary will receive an after-tax rate of return of 3.85% on the capital gain and 4.55% on the non-eligible dividends.
D) There is no difference in the after-tax rate of return on the two investments.

Accepted Answer

To determine the after-tax rate of return for each investment, we need to calculate the tax payable on each return and deduct it from the original return.

For the capital gain, the tax payable is 23% of the gain (since Mary's marginal tax rate for capital gains is 23%). Therefore, the after-tax rate of return for the capital gain is:

5% x (1 - 0.23) = 3.85%

For the non-eligible dividend, the tax payable is 35% of the dividend (since Mary's marginal tax rate for non-eligible dividends is 35%). Therefore, the after-tax rate of return for the non-eligible dividend is:

7% x (1 - 0.35) = 4.55%

Since the after-tax rate of return for the non-eligible dividend is higher than that for the capital gain, Mary should choose to invest in the non-eligible dividend for a higher return. Therefore, the best choice is:

C) Mary will receive an after-tax rate of return of 3.85% on the capital gain and 4.55% on the non-eligible dividends.

Question 6

Jet Dry Inc.is undergoing a sale/leaseback arrangement on a piece of its equipment.The equipment has a fair market value of $250,000,and currently generates $75,000 in annual revenue.The lease agreement is for five years,with no residual value at the end of the term.The annual leasing cost is $55,000.
The current UCC of the equipment is $150,000.Other assets will remain in the asset pool,and recapture will not occur as a result of the sale.
The company is subject to a corporate tax rate of 25%,and achieves a 12% after-tax rate of return.
Required:
Calculate the net present value of the cash flow that will result from this sale-and-leaseback arrangement.(Round all numbers to zero decimal points.)

Accepted Answer

The answer of Jet Dry Inc.is undergoing a sale/leaseback arrangement...

Question 7

Which of the following statements regarding preferred share financing is false?&#10;A) Preferred share dividend payments are non-deductible.&#10;B) There is a special tax on preferred dividends in excess of $500,000 annually, even if the issuing corporation has no taxable income.&#10;C) Current tax laws simplify the nature of preferred share financing for corporations.&#10;D) The preferred share issue may be structured so as to enhance the after-tax return of investors.

Accepted Answer

Current tax laws do not simplify the nature of preferred share financing for corporations. Instead, preferred share financing can be complicated due to various tax implications, such as the special tax on preferred dividends in excess of $500,000 annually. The other statements are true - preferred share dividend payments are non-deductible, the preferred share issue may be structured to enhance after-tax return of investors, and there is a special tax on preferred dividends in excess of $500,000 annually.

Question 8

During the year,The Light Corporation paid $550,000 in preferred share dividends to ABC Inc.Both companies are Canadian corporations.Which of the following is true?&#10;A) ABC Inc. will have to pay Part VI.1 tax on the dividend, regardless of whether or not it has taxable income.&#10;B) The Light Corporation will have to pay Part VI.1 tax on the dividend, regardless of whether or not it has taxable income.&#10;C) ABC Inc. will have to pay Part VI.1 tax on the dividend, only if it has taxable income.&#10;D) The Light Corporation will have to pay Part VI.1 tax on the dividend, only if it has taxable income.

Accepted Answer

The Light Corporation, as the payer of the preferred share dividends, is responsible for paying Part VI.1 tax on the dividends, regardless of its taxable income status.

Deck 21: Tax Aspects of Corporate Financing