Question 1

A corporation recently purchased some preferred stock that has a before-tax yield of 7 percent. The company has a tax rate of 40 percent. What is the after-tax yield on the preferred stock?

Accepted Answer

The answer of A corporation recently purchased some preferred stock...

Question 2

Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6 percent, and Carter's marginal income tax rate is 40 percent, what yield on the Chicago municipal bonds would make Carter's treasurer indifferent between the two?

Accepted Answer

The answer of Carter Corporation has some money to invest,...

Question 3

Byrd Lumber has 2 million shares of stock outstanding. On the balance sheet the company has $40 million worth of common equity. The company's stock price is $15 a share. What is the company's Market Value Added (MVA)?

Accepted Answer

The Market Value Added (MVA) is calculated as the difference between the market value of the company's equity and the book value of its equity. The market value of equity is 2 million shares * $15 = $30 million. The book value of equity is $40 million. Therefore, MVA = $30 million - $40 million = -$10 million.

Question 4

Garfield Industries is expanding its operations throughout the Southeast United States. Garfield anticipates that the expansion will increase sales by $1,000,000, and increase the costs of goods sold by $700,000. Depreciation expenses will rise by $50,000 and interest expense will increase by $150,000. The company's tax rate will remain at 40 percent. If the company's forecast is correct, how much will net income increase or decrease, as a result of the expansion?

Accepted Answer

The net income change is calculated as follows: Increase in sales ($1,000,000) - Increase in COGS ($700,000) - Increase in depreciation ($50,000) - Increase in interest expense ($150,000) = $100,000. Tax on $100,000 at 40% = $40,000. Therefore, net income increase = $100,000 - $40,000 = $60,000.

Question 5

A 5-year corporate bond yields 9 percent. A 5-year municipal bond of equal risk yields 6.5 percent. Assume that the state tax rate is zero. At what federal tax rate are you indifferent between the two bonds?

Accepted Answer

The correct answer is A because at a federal tax rate of 27.78%, the after-tax yield on the corporate bond will be equal to the after-tax yield on the municipal bond.

Question 6

Bates Motors has the following information for the previous year: Net income = $200; Net operating profit after taxes (NOPAT) = $300; Total assets = $1,000; and Total net operating capital = $800. The information for the current year is: Net income = $500; Net operating profit after taxes (NOPAT) = $400; Total assets = $1,300; and Total net operating capital = $900. What is the free cash flow for the current year?

Accepted Answer

Free cash flow = NOPAT - (Net investment in operating capital)
Net investment in operating capital = Total net operating capital (current year) - Total net operating capital (previous year) = ($900 - $800) = $100
Free cash flow = $400 - $100 = $300. Therefore, the correct answer is (C) $300.

Question 7

Strother Inc. has the following information for the previous year: Net income = $400; Net operating profit after taxes (NOPAT) = $600; Total assets = $2,000; and Total net operating capital = $1800. The information for the current year is: Net income = $900; Net operating profit after taxes (NOPAT) = $800; Total assets = $2,300; and Total net operating capital = $2200. What is the free cash flow for the current year?

Accepted Answer

Free cash flow is calculated as NOPAT minus the change in total net operating capital. The change in total net operating capital is $2200 - $1800 = $400. Therefore, free cash flow = $800 - $400 = $400.

Question 8

Spencer Inc. has the following information for the current year: Net income = $600; Net operating profit after taxes (NOPAT) = $500; Total assets = $4,000; Short-term investments = $500; Stockholders equity = $2,000; Debt = $1,000; and Total net operating capital = $2500. If Spencer's cost of capital is 10%, what is its Economic value added (EVA)?

Accepted Answer

EVA is calculated as NOPAT minus the product of Total net operating capital and the cost of capital. EVA = $500 - ($2500 * 0.10) = $500 - $250 = $250.

Question 9

A seven-year municipal bond yields 4.8 percent. Your marginal tax rate (including state and federal taxes) is 28 percent. What interest rate on a seven-year corporate bond of equal risk would provide you with the same after-tax return?

Accepted Answer

To find the equivalent corporate bond yield, use the formula: Municipal Yield / (1 - Tax Rate). So, 4.8% / (1 - 0.28) = 6.67%.

Question 10

Giglio Inc. has the following information for the previous year: Net income = $400; Net operating profit after taxes (NOPAT) = $500; Total assets = $2,000; and Total operating capital = $1700. The information for the current year is: Net income = $800; Net operating profit after taxes (NOPAT) = $700; Total assets = $2,300; and Total operating capital = $2100. What is the free cash flow for the current year?

Accepted Answer

Free cash flow = NOPAT + Depreciation and amortization - Change in operating capital= 700 + (2300 - 2000) - (2100 - 1700)= 700 + 300 - 400= $600

Question 11

A corporate bond currently yields 8.5 percent. Municipal bonds with the same risk, maturity, and liquidity currently yield 5.5 percent. At what tax rate would investors be indifferent between the two bonds?

Accepted Answer

The tax rate at which investors would be indifferent is calculated using the formula: Tax Rate = 1 - (Municipal Yield / Corporate Yield). Substituting the given yields: Tax Rate = 1 - (5.5% / 8.5%) = 1 - 0.6471 = 0.3529 or 35.29%.

Question 12

Tibbs Inc. has the following information for the current year: Net income = $300; Net operating profit after taxes (NOPAT) = $400; Total assets = $2,900; Short-term investments = $200; Stockholders equity = $1,800; Debt = $700; and Total net operating capital = $2300. What is the Return on invested capital (ROIC) for the current year?

Accepted Answer

ROIC is calculated as NOPAT divided by Total net operating capital.

ROIC = NOPAT / Total net operating capital

ROIC = $400 / $2,300

ROIC = 0.174 or 17.4%

Therefore, the answer is D) 17.4%.

Question 13

A corporation with a marginal tax rate of 35 percent would receive what after-tax dividend yield on a 12 percent coupon rate preferred stock bought at par, assuming a 70 percent dividend exclusion?

Accepted Answer

First, we need to calculate the before-tax dividend yield on the preferred stock. This is simply the coupon rate of 12% multiplied by the par value of the stock. Therefore:

Before-tax dividend yield = 12% x $100 = $12 per year

Next, we need to figure out how much of this dividend will be excluded from the corporation's taxable income due to the 70% dividend exclusion. This is calculated as:

Excluded dividend = $12 x 70% = $8.40 per year

Finally, we can calculate the after-tax dividend yield on the preferred stock by subtracting the taxes on the remaining $3.60 of dividend income (assuming a marginal tax rate of 35%). Therefore:

After-tax dividend yield = $8.40 - ($3.60 x 35%) = $8.40 - $1.26 = $7.14 per year

So the after-tax dividend yield is $7.14 per year on a $100 investment, or 7.14%. However, since the answer choices are listed as percentages rounded to two decimal places, we need to multiply this result by 100 and round to the nearest hundredth. This gives us an answer of 10.74%, or choice B.

Question 14

Spencer Inc. has the following information for the current year: Net income = $600; Net operating profit after taxes (NOPAT) = $500; Total assets = $4,000; Short-term investments = $500; Stockholders equity = $2,000; Debt = $1,000; and Total net operating capital = $2500. What is the Return on invested capital (ROIC) for the current year?

Accepted Answer

ROIC is calculated as NOPAT divided by Total net operating capital. Here, ROIC = $500 / $2500 = 0.20 or 20.0%.

Question 15

Sanguillen Corp. showed retained earnings of $400,000 on its balance sheet last year. This year, the company's earnings per share (EPS) were $3.00 and its dividends paid per share (DPS) were $1.00. The company has 200,000 shares of stock outstanding. What is the level of retained earnings on the company's balance sheet this year?

Accepted Answer

The answer of Sanguillen Corp. showed retained earnings of $400,000...

Question 16

A corporation can earn 7.5 percent if it invests in municipal bonds. The corporation can also earn 8.5 percent (before-tax) by investing in preferred stock. Assume that the two investments have equal risk. What is the break-even corporate tax rate which makes the corporation indifferent between the two investments?

Accepted Answer

To calculate the break-even corporate tax rate, we need to set the two investment options equal and solve for the tax rate.

0.075 = (1 - t) * 0.085
0.075 = 0.085 - 0.085t
0.01 = 0.085t
t = 0.01 / 0.085
t = 0.1176 or 11.76%

However, this is the before-tax break-even point. To find the after-tax break-even point, we need to calculate the tax-adjusted return of the preferred stock investment:

0.085 * (1 - t) = 0.075
0.085 - 0.085t = 0.075
0.01 = 0.085t
t = 0.01 / 0.085
t = 0.1176 or 11.76%

Now we can see that the break-even corporate tax rate is 11.76%, which is equivalent to an effective tax rate of 39.22% (1 - 0.1176) due to the double taxation of corporate profits. Therefore, if the corporate tax rate is expected to be greater than 39.22%, investing in municipal bonds is a better option to maximize the return on investment.

Question 17

Hayes Corporation has $300 million worth of common equity on its balance sheet, and 6 million shares of stock outstanding. The company's Market Value Added (MVA) is $162 million. What is the company's stock price?

Accepted Answer

The answer of Hayes Corporation has $300 million worth of...

Question 18

New Mexico Lumber recently reported that its earnings per share were $3.00. The company has 400,000 shares of stock outstanding. The company's interest expense was $500,000. The corporate tax rate is 40 percent. What was the company's operating income (EBIT)?

Accepted Answer

The answer of New Mexico Lumber recently reported that its...

Question 19

Edge Brothers recently reported net income of $385,000. The tax rate is 40 percent. The company's interest expense was $200,000. What would have been the company's net income if they would have been able to double their operating income (EBIT), assuming that the company's tax rate and interest expense remain unchanged?

Accepted Answer

To find the new net income, first calculate the original EBIT using the formula: Net Income = (EBIT - Interest) * (1 - Tax Rate). Rearranging gives EBIT = (Net Income / (1 - Tax Rate)) + Interest. Plugging in the values: EBIT = ($385,000 / 0.6) + $200,000 = $841,667. Doubling EBIT gives $1,683,334. The new net income is: ($1,683,334 - $200,000) * 0.6 = $890,000.

Question 20

New Hampshire Services reported $2.3 million of retained earnings on its balance sheet last year. This year, the company lost money--its net income was -$500,000 (negative $500,000). Despite the loss, the company still paid a $1.00 per share dividend this year. The company's earnings per share for this year were -$2.50 (negative $2.50). What was the level of retained earnings on the company's balance sheet this year?

Accepted Answer

The answer of New Hampshire Services reported $2.3 million of...

Quiz 7: Accounting for Financial Management