Chapter Two:

The Financial Market Environment

Problems #P2-1, P2-5; page 49.

Problem #P2-1:

Part a: Corporate Taxes

Tantor Supply Inc.’s Earning during 2013 = $92,500

Tax Liability = Taxes Due on Base + ( Taxable Income - Base of Bracket ) Tax Rate
of Bracket

Tax Liability = $13,750 + ( $92,500 - $75,000 ) x 34%

Tax Liability = $13,750 + ( $17,500 )x .34 =

Tax Liability = $13,750 + $5,950 = $19,700

Part b: After-Tax Earnings:

Tantor Supply Inc.’s Pre-Tax Earnings = $92,500

Tantor Supply Inc.’s Taxes Due on Pre-Tax Earnings = $19,700

“After-Tax Earnings” can be calculated using the following formula:

After-Tax Earnings = Pre-Tax Earnings - Taxes Due

After-Tax Earnings = $92,500 - $19,700 = $72,800

Part c: Average Tax Rate:

A firm’s “average tax rate” can be calculated with the following formula:

Average Tax Rate = Taxes Due

Pre-Tax Income

For Tantor Supply Inc., “average tax rate” is as follows:

Average Tax Rate = $19,700 = 21.30%

$92,500

1
Part d: Marginal Tax Rate

As Tantor Supply Inc.’s Earning during 2013 is $92,500 which is According to Table 2.1 –
Corporate Tax Rate Schedule, Slab-III, is crossing $75,000. Therefore, marginal tax rate will be
34%.

Problem #P2-5: Interest Expense vs. Dividend Payments

Part a: Earnings After Taxes with “Interest Expense”:

Earnings Before Interest and Taxes (EBIT) $50,000

Less: Interest Expense $12,000
Earnings Before Taxes (EBT) $38,000
Less: Income Tax Expense $13,300
EBT x 35% => $38,000 x 35%
Earnings After Taxes $24,700

Note:
No dividend is considered in calculation.

Part b: Earnings After Taxes with “Preferred Stock Dividends”:

Earnings Before Interest and Taxes (EBIT) $50,000

Less: Interest Expense -
Earnings Before Taxes (EBT) $50,000
Less: Income Tax Expense $17,500
EBT x 35% => $50,000 x 35%
Earnings After Taxes $32,500

Less: Preferred Dividend paid $12,000

Earnings available for common Stockholder $20,500

Note:
No interest payment is considered in calculation.