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Tax Problems

You have sales of $250,000 and cost of goods sold (materials and labor) comes to $155,000. Assuming no other income or expenses

a. what is your tax bill?
b. what is the marginal rate?
c. what is the average rate?

The problem above continues. In addition to the above, you have posted $10,000 in interest income and paid $25, 000 in common stock dividends.

a. what is your new tax bill?
b. what is the new marginal rate?
c. what is the new average rate?

• Tax Problem

Good old XYZ Corporation had sales this past year of $450,000. Their cost of goods sold came to $200,000. They eventually plan to expand their operation but due to the current economic situation they have decided to postpone any new investment in plant and equipment and therefore invested their extra cash in McDonald’s stock. That turned out to be a fairly good move as they received this year a dividend check from Mc’Ds for $6,000. In order to keep their own stockholders happy, they increased their dividend payout ratio to 50% of their net profits.
This resulted in XYZ paying a record amount in common stock dividends for the year: $22,500.
Using the tax chart on page 46 in your text, compute XYZs federal tax bill.

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• Solution to Tax Problem

$450,000 – $200,000 = $250,000 + $1,800* = $251,800 NPBT
$50,000 x .15 = $7,500
$25,000 x .25 = $6,250
$2,500 x .34 = $8,500
$151,800 x .39 = $59,202
$81,452

* For the Mc’Ds dividend income, remember 70% is excluded fro tax, therefore only 30% of the $6,000 is taxable.
OK – what would be their marginal tax rate? Answer: 39%

How about their average tax rate? Answer 32.35% And yes I need the answer to two decimal places! Also note, tax rates are always expressed as percentages – do not leave them as decimals. Be sure to remember that for all “rates” or “rate of return” in the course. For example: ROE, Return on Equity, is expressed as a percentage, not a decimal, and yes, it does matter

Answers

1a: $20,550
1b: 34%
1c: 21.63%

2a: $24,200
2b: 39%
2c: 23.05%

Problem for Section 6.1

The Smyrna Local Organizational Bank (SLOB) wants to sell some 6 month CDs. SLOB wants to pay just enough interest to attract customers, but since the bank’s management took all their finance courses distance learning ( just kidding!), they couldn’t remember how interest rates are determined – something about all those group projects.
Fortunately, “the kid” across the street who works at McDonalds is taking courses from (HERE IT COMES!) Wilmington University and tells then all about the following equation

. r1 = r* + IP + Risk

Assume that the Risk Premium for SLOB is 6% and expected inflation is 3%. The only other information that can be found is a list of current interest rates

3-month T-Bill = 2%
30-year T-Bond = 5.5%
Prime = 4%
Given the above, what interest rate should SLOB pay on their new 6-moht CDs?

Oh, and the kid from McD’s didn’t think much of their advertising slogan (which aimed to keep customers for life):
“Once a SLOB, always a SLOB”

Solution
Using the formula: r1 = r* + IP + Risk is a problem, unless you remember that r* + IP = the risk free (Rf) rate AND Rf can be approximated by the 90-day T-Bill rate, here 2%. So the answer becomes
. r1 = Rf + Risk = 2% + 6% = 8%

Be careful. I know I asked for the rate on 6 month CDs. You may be tempted to double the 90-day T-Bill rate (heck, that would be 6 months!) WRONG. It doesn’t matter how long the investment is for, just use the 90-Day T-Bill rate.

Product Code-Taxation-AW-Q315

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