TEST BANK CHAPTER 03 FINANCIAL STATEMENTS CASH FLOW AND TAXES

CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES This chapter has a lot of definitions They are important, but we don't like to make students memorize too many of them early in the course We let our students use a formula sheet that includes the key definitions Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F statements are used in multiple-choice questions Multiple Choice: True/False The annual report contains four basic financial statements: the income statement, the balance sheet, the cash flow statement, and statement of stockholders' equity a True b False ANSWER: True The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows a True b False ANSWER: True Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet, and the cash flow statement a True b False ANSWER: False On the balance sheet, total assets must always equal the sum of total liabilities and equity a True b False ANSWER: True KEYWORDS: Bloom’s: Knowledge Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be higher or lower than the amounts at which the assets are carried on the books a True b False ANSWER: True KEYWORDS: Bloom’s: Knowledge The amount shown on the December 31, 2015, balance sheet as "retained earnings" is equal to the firm's net income for 2015 minus any dividends it paid a True b False ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 3-2 The Balance Sheet Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Balance sheet KEYWORDS: Bloom’s: Knowledge The income statement shows the difference between a firm's income and its costs i.e., its profits­­during a specified period of time However, not all reported income comes in the form of cash, and reported costs likewise may not be consistent with cash outlays Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period a True b False ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Income statement KEYWORDS: Bloom's: Comprehension If we were describing the income statement and the balance sheet, it would be correct to say that the income statement is more like a video while the balance sheet is more like a snapshot a True b False ANSWER: True EBIT stands for earnings before interest and taxes, and it is often called "operating income." a True b False ANSWER: True 10 EBITDA stands for earnings before interest, taxes, debt, and assets a True b False ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 3-3 The Income Statement LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES TOPICS: KEYWORDS: Income statement Bloom’s: Knowledge 11 Consider the following balance sheet, for Games Inc Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000 Cash Inventory Accounts receivable Total CA Net fixed assets $ 50,000 200,000 250,000 $ 500,000 $ 900,000 Total assets $1,400,000 Accounts payable Accruals Total CL Long-term debt Common stock Retained earnings Total L & E $ 100,000 100,000 $ 200,000 200,000 200,000 800,000 $1,400,000 a True b False ANSWER: RATIONALE: False Note that the firm has only $50,000 of cash It would have to either sell assets or borrow $150,000 to pay cash for the new asset That might not be possible POINTS: DIFFICULTY: EASY REFERENCES: 3-5 Statement of Stockholders’ Equity LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Retained earnings KEYWORDS: Bloom's: Comprehension 12 Typically, the statement of stockholders' equity starts with total stockholders' equity at the beginning of the year, adds net income, subtracts dividends paid, and ends up with total stockholders' equity at the end of the year Over time, a profitable company will have earnings in excess of the dividends it pays out, and will result in a substantial amount of retained earnings shown on the balance sheet a True b False ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 3-5 Statement of Stockholders’ Equity LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Stockholders' equity statement KEYWORDS: Bloom's: Comprehension Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES 13 Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations a True b False ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 3-7 Free Cash Flow LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Free cash flow KEYWORDS: Bloom’s: Knowledge 14 The value of any asset is the present value of the cash flows the asset is expected to provide The cash flows a business is able to provide to its investors is its free cash flow This is the reason that FCF is so important in finance a True b False ANSWER: True POINTS: DIFFICULTY: EASY REFERENCES: 3-7 Free Cash Flow LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Free cash flow KEYWORDS: Bloom’s: Knowledge 15 If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow a True b False ANSWER: False RATIONALE: There is no reason to think that net income would be equal to FCF For example, a company that is not growing might report zero net income yet have high FCF because of depreciation POINTS: DIFFICULTY: EASY REFERENCES: 3-7 Free Cash Flow LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Free cash flow KEYWORDS: Bloom's: Comprehension Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES 16 The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision a True b False ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 3-9 Income Taxes LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Income taxes KEYWORDS: Bloom’s: Knowledge 17 Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes a True b False ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: 3-9 Income Taxes LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Income taxes KEYWORDS: Bloom’s: Knowledge 18 The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time a True b False ANSWER: False POINTS: DIFFICULTY: EASY REFERENCES: Comprehensive LEARNING OBJECTIVES: FOFM.BRIG.16.03.00 - Comprehensive NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Financial statements KEYWORDS: Bloom’s: Knowledge 19 Assume that two firms are both following generally accepted accounting principles Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES fixed assets The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors a True b False ANSWER: False RATIONALE: One firm might choose to use straight-line depreciation, the other an accelerated method, and this would lead to differences in reported depreciation and therefore reported net fixed assets POINTS: DIFFICULTY: MODERATE REFERENCES: 3-2 The Balance Sheet LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Retained earnings KEYWORDS: Bloom's: Comprehension 20 Net operating working capital is equal to current assets minus the difference between current liabilities and notes payable This definition assumes that the firm has no "excess" cash a True b False ANSWER: True POINTS: DIFFICULTY: MODERATE REFERENCES: 3-2 The Balance Sheet LEARNING OBJECTIVES: FOFM.BRIG.16.03.02 - The Balance Sheet NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Net operating working capital KEYWORDS: Bloom’s: Knowledge 21 The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid Therefore, the dividends are frequently called "the bottom line." a True b False ANSWER: False POINTS: DIFFICULTY: MODERATE REFERENCES: 3-3 The Income Statement LEARNING OBJECTIVES: FOFM.BRIG.16.03.03 - The Income Statement NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Income statement KEYWORDS: Bloom’s: Knowledge Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES 22 The statement of cash flows has four main sections, one each for operating, investing, and financing activities, and one that shows a summary of the cash and cash equivalents at the end of the year a True b False ANSWER: True POINTS: DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Statement of cash flows KEYWORDS: Bloom’s: Knowledge 23 An increase in accounts payable represents an increase in net cash provided by operating activities just like borrowing money from a bank An increase in accounts payable has an effect similar to taking out a new bank loan However, these two items show up in different sections of the statement of cash flows to reflect the difference between operating and financing activities a True b False ANSWER: True POINTS: DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Statement of cash flows KEYWORDS: Bloom's: Comprehension 24 An increase in accounts receivable represents an increase in net cash provided by operating activities because receivables will produce cash when they are collected a True b False ANSWER: False POINTS: DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Statement of cash flows Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES KEYWORDS: Bloom's: Comprehension 25 The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that represent increases or decreases to cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt a True b False ANSWER: False RATIONALE: Rapidly growing firms often require additions to inventory and receivables that are larger than net income, with the deficit being made up by borrowings and/or the sale of new stock POINTS: DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Statement of cash flows KEYWORDS: Bloom's: Comprehension 26 To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue in the net income calculation a True b False ANSWER: True POINTS: DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Statement of cash flows KEYWORDS: Bloom’s: Knowledge 27 Two metrics that are used to measure a company's financial performance are net income and cash flow Accountants emphasize net income as calculated in accordance with generally accepted accounting principles Finance people generally put at least as much weight on cash flows as they on net income a True b False ANSWER: True POINTS: DIFFICULTY: MODERATE REFERENCES: 3-4 Statement of Cash Flows LEARNING OBJECTIVES: FOFM.BRIG.16.03.04 - Statement of Cash Flows Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows Cash flow and net income Bloom’s: Knowledge 28 Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid out to stockholders as dividends If the firm has sufficient retained earnings, it can purchase assets and pay for them with cash from retained earnings a True b False ANSWER: False POINTS: DIFFICULTY: MODERATE REFERENCES: 3-5 Statement of Stockholders’ Equity LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Retained earnings KEYWORDS: Bloom’s: Knowledge 29 The retained earnings account on the balance sheet does not represent cash Rather, it represents part of the stockholders' claims against the firm's existing assets Put another way retained earnings are stockholders' reinvested earnings a True b False ANSWER: True POINTS: DIFFICULTY: MODERATE REFERENCES: 3-5 Statement of Stockholders’ Equity LEARNING OBJECTIVES: FOFM.BRIG.16.03.05 - Statement of Stockholders' Equity NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Retained earnings KEYWORDS: Bloom’s: Knowledge 30 In finance, we are generally more interested in cash flows than in accounting profits Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and changes in net operating working capital a True b False ANSWER: True POINTS: DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow Cengage Learning Testing, Powered by Cognero Page CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows Free cash flow Bloom’s: Knowledge 31 Free cash flow is the amount of cash that if withdrawn would harm the firm's ability to operate and to produce future cash flows a True b False ANSWER: False POINTS: DIFFICULTY: MODERATE REFERENCES: 3-7 Free Cash Flow LEARNING OBJECTIVES: FOFM.BRIG.16.03.07 - Free Cash Flow NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows TOPICS: Free cash flow KEYWORDS: Bloom’s: Knowledge 32 If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a taxdeductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant a True b False ANSWER: False POINTS: DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function TOPICS: Income taxes KEYWORDS: Bloom's: Comprehension 33 Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible This treatment, other things held constant, tends to encourage the use of debt financing by corporations a True b False ANSWER: True POINTS: DIFFICULTY: MODERATE REFERENCES: 3-9 Income Taxes LEARNING OBJECTIVES: FOFM.BRIG.16.03.09 - Income taxes NATIONAL STANDARDS: United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills Cengage Learning Testing, Powered by Cognero Page 10 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES 115 Allen Corporation can (1) build a new plant that should generate a before-tax return of 11%, or (2) invest the same funds in the preferred stock of Florida Power & Light (FPL), which should provide Allen with a before-tax return of 9%, all in the form of dividends Assume that Allen's marginal tax rate is 25%, and that 70% of dividends received are excluded from taxable income If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximize Allen's effective return on the money invested? a All in the plant project b All in FPL preferred stock c 60% in the project; 40% in FPL d 60% in FPL; 40% in the project e 50% in each ANSWER: b BT project return 11.00% RATIONALE: BT preferred return Tax rate Dividend exclusion % 9.00% 25.00% 70.00% After-tax return on project = BT project return × (1 − T) After-tax return on project = 8.25% After-tax return on pref = BT pref return[1 − (1 − Div exclusion %)(T)] After-tax return on pref = 8.33% POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function After-tax returns–nonalgorithmic Bloom's: Evaluation Multiple Choice: Problem 116 Solarcell Corporation has $20,000 that it plans to invest in marketable securities It is choosing between AT&T bonds that yield 11%, State of Florida municipal bonds that yield 8%, and AT&T preferred stock with a dividend yield of 9% Solarcell's corporate tax rate is 40%, and 70% of the preferred stock dividends it receives are tax exempt Assuming that the investments are equally risky and that Solarcell chooses strictly on the basis of after-tax returns, which security should be selected? Answer by giving the after-tax rate of return on the highest yielding security a 7.80% b 8.00% c 8.20% d 8.41% e 8.62% ANSWER: b BT bond yield 11.00% RATIONALE: BT municipal bond yield BT preferred yield Tax rate Dividend exclusion % 8.00% 9.00% 40.00% 70.00% Since municipal bonds are exempt from federal taxes, its BT return = AT return Cengage Learning Testing, Powered by Cognero Page 58 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES AT municipal bond yield = 8.00% AT bond yield = BT bond yield × (1 − T) AT bond yield = 6.60% AT preferred yield = BT pref return[1 − (1 − Div exclusion %)(T)] AT preferred yield = 7.92% Highest AT yield = 8.00% POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function After-tax returns Bloom's: Evaluation Multiple Choice: Problem 117 A corporation can earn 7.5% if it invests in municipal bonds The corporation can also earn 8.5% (before-tax) by investing in preferred stock Assume that the two investments have equal risk What is the break-even corporate tax rate that makes the corporation indifferent between the two investments? a 35.39% b 37.25% c 39.22% d 41.18% e 43.24% ANSWER: c BT Preferred stock yield 8.50% RATIONALE: Municipal yield Dividend exclusion % 7.50% 70.00% Remember that municipal bonds are tax exempt, so their BT yield = AT yield Municipal yield = After-tax preferred yield 7.50% = BT pref return × [1 − (1 − Div exclusion %)(T)] 7.50% = 8.50% × [1 − 30.00% × (T)] 88.24% = [1 − 30.00% × (T)] T = 39.22% POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows After-tax returns Bloom's: Analysis Multiple Choice: Problem Cengage Learning Testing, Powered by Cognero Page 59 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES 118 Mantle Corporation is considering two equally risky investments: ∙ A $5,000 investment in preferred stock that yields 7% ∙ A $5,000 investment in a corporate bond that yields 10% What is the break-even corporate tax rate that makes the company indifferent between the two investments? a 34.27% b 36.08% c 37.97% d 39.87% e 41.87% ANSWER: c BT Preferred stock yield 7.00% RATIONALE: Dividend exclusion % BT bond yield 70.00% 10.00% AT bond yield = After-tax preferred yield BT bond yield × (1 − T) = BT pref return × [1 − (1 − Div exclusion %)(T)] 10.00% × (1 − T) = 7.00% × [1 − 30.00% × (T)] 3.00% = 7.900%(T) T = 37.97% POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function After-tax returns Bloom's: Evaluation Multiple Choice: Problem 119 West Corporation has $50,000 that it plans to invest in marketable securities The corporation is choosing between the following three equally risky securities: Alachua County tax-free municipal bonds yielding 8.5%; Exxon Mobil bonds yielding 10.5%; and GM preferred stock with a dividend yield of 9.25% West's corporate tax rate is 35% What is the after-tax return on the best investment alternative? (Assume the company chooses on the basis of after-tax returns.) a 8.500% b 8.925% c 9.371% d 9.840% e 10.332% ANSWER: a BT municipal bond yield 8.50% RATIONALE: BT bond yield BT preferred yield Tax rate Dividend exclusion % Cengage Learning Testing, Powered by Cognero 10.50% 9.25% 35.00% 70.00% Page 60 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES Since municipal bonds are exempt from federal taxes, its BT return = AT return AT municipal bond yield = 8.500% AT bond yield = BT bond yield × (1 − T) AT bond yield = 6.825% AT preferred yield = BT pref return[1 − (1 − Div exclusion%)(T)] AT preferred yield = 8.279% Highest AT yield = 8.500% POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function After-tax returns Bloom's: Evaluation Multiple Choice: Problem 120 Arvo Corporation is trying to choose between three alternative investments The three securities that the company is considering are as follows: ∙ Tax-free municipal bonds with a return of 8.8% ∙ Wooli Corporation bonds with a return of 11.75% ∙ CFI Corp preferred stock with a return of 9.8% The company's tax rate is 25% What is the after-tax return on the best investment alternative? a 7.383% b 7.772% c 8.181% d 8.612% e 9.065% ANSWER: e BT municipal bond yield 8.80% RATIONALE: BT bond yield BT preferred yield Tax rate Dividend exclusion % 11.75% 9.80% 25.00% 70.00% Since municipal bonds are exempt from federal taxes, its BT return = AT return AT municipal bond yield = 8.800% AT bond yield = BT bond yield × (1 − T) AT bond yield = 8.813% AT preferred yield = BT pref return[1 − (1 − Div exclusion %)(T)] AT preferred yield = 9.065% Highest AT yield = 9.065% Cengage Learning Testing, Powered by Cognero Page 61 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function After-tax returns Bloom's: Evaluation Multiple Choice: Problem 121 Collins Co began operations in 2011 The company lost money the first two years, but has been profitable ever since The company's taxable income (EBT) for its first four years is summarized below: Year EBT −$3,000,000 2011 −$5,200,000 2012 2013 $4,200,000 2014 $8,300,000 The corporate tax rate has remained at 34% Assume that the company has taken full advantage of the Tax Code's carryback, carry-forward provisions, and assume that the current provisions were applicable in 2011 What is Collins' tax liability for 2014? a $1,069,848 b $1,188,720 c $1,320,800 d $1,462,00 e $1,617,200 ANSWER: d Tax rate 34% RATIONALE: Year 2011 2012 2013 2014 Taxable Carry-Forward Income Used −$3,000,000 $0 −$5,200,000 $0 $4,200,000 $4,200,000 $8,300,000 $4,000,000 EBT After Forward Applied $0 $0 $0 $4,300,000 Unused Carryable Amount $3,000,000 $8,200,000 $4,000,000 $0 2014 Tax liability = EBT × Tax rate 2014 Tax liability = $1,462,000 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Carry-back, carry-forward Cengage Learning Testing, Powered by Cognero Page 62 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES KEYWORDS: OTHER: Bloom’s: Analysis Multiple Choice: Problem 122 Salinger Software was founded in 2011 The company lost money each of its first three years, but was able to turn a profit in 2014 Salinger's operating income (EBIT) for its first four years of operations is reported below Year EBIT −$ 50,000,000 2011 −$150,000,000 2012 −$100,000,000 2013 2014 $700,000,000 The company has no debt, so operating income equals earnings before taxes The corporate tax rate has remained constant at 35% Assume that the company took full advantage of the carry-back, carry-forward provisions in the Tax Code, and assume that the current provisions were applicable in 2011 How much tax did the company pay in 2014? a $114,030,875 b $120,032,50 c $126,350,00 d $133,000,00 e $140,000,00 ANSWER: e Tax rate 35% RATIONALE: Year 2011 2012 2013 2014 Taxable Income −$ 50,000,000 −$150,000,000 −$100,000,000 $700,000,000 Carry-Forward Used $0 $0 $0 $300,000,000 EBT After Forward Applied $0 $0 $0 $400,000,000 Unused Carryable Amount $ 50,000,000 $200,000,000 $300,000,000 $0 2014 Tax liability = EBT × Tax rate 2014 Tax liability = $140,000,000 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Carry-back, carry-forward Bloom’s: Analysis Multiple Choice: Problem 123 Bradshaw Beverages began operations in 2010 The table below contains the company's taxable income during each year of its operations Notice that the company lost money in each of its first three years The corporate tax rate has been 40% each year Cengage Learning Testing, Powered by Cognero Page 63 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES Year Taxable Income −$ 700,000 2010 −$ 500,000 2011 −$ 200,000 2012 2013 $ 800,000 2014 $1,000,000 Assume that the company has taken full advantage of the Tax Code's carry-back, carry-forward provisions, and assume that the current provisions were applicable in 2010 How much did the company pay in taxes during 2014? a $160,000 b $168,000 c $176,40 d $185,220 e $194,48 ANSWER: a Tax rate 40% RATIONALE: Year 2010 2011 2012 2013 2014 Taxable Income −$ 700,000 −$ 500,000 −$ 200,000 $ 800,000 $1,000,000 Carry-Forward Used $0 $0 $0 $800,000 $600,000 EBT After Forward Applied $0 $0 $0 $0 $400,000 Unused Carryable Amount $ 700,000 $1,200,000 $1,400,000 $ 600,000 $0 2014 Tax liability = EBT × Tax rate 2014 Tax liability = $160,000 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Carry-back, carry-forward Bloom’s: Analysis Multiple Choice: Problem 124 Uniontown Books began operating in 2010 The company lost money its first three years of operations, but has had an operating profit during the past two years The company's operating income (EBIT) for its first five years was as follows: Year EBIT −$3,600,000 2010 −$2,000,000 2011 −$1,000,000 2012 2013 $1,200,000 2014 $7,000,000 The company has no debt, and therefore, pays no interest expense Its corporate tax rate has remained at 34% during this Cengage Learning Testing, Powered by Cognero Page 64 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES 5-year period What was Uniontown's tax liability for 2014? (Assume that the company has taken full advantage of the carry-back and carry-forward provisions, and assume that the current provisions were applicable in 2010.) a $466,41 b $490,96 c $516,800 d $544,00 e $571,20 ANSWER: d Tax rate 34% RATIONALE: Year 2010 2011 2012 2013 2014 Taxable Income −$3,600,000 −$2,000,000 −$1,000,000 $1,200,000 $7,000,000 Carry-Forward Used $0 $0 $0 $1,200,000 $5,400,000 EBT After Forward Applied $0 $0 $0 $0 $1,600,000 Unused Carryable Amount $3,600,000 $5,600,000 $6,600,000 $5,400,000 $0 2014 Tax liability = EBT × Tax rate 2014 Tax liability = $544,000 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Carry-back, carry-forward Bloom’s: Analysis Multiple Choice: Problem 125 Mays Industries was established in 2009 Since its inception, the company has generated the following levels of taxable income (EBT): Year Taxable Income 2009 $ 50,000 2010 $ 40,000 2011 $ 30,000 2012 $ 20,000 −$100,000 2013 2014 $ 60,000 Assume that each year the company has faced a 40% income tax rate Also, assume that the company has taken full advantage of the Tax Code's carry-back, carry-forward provisions, and assume that the current provisions were applicable in 2008 What is the company's tax liability for 2014? a $4,00 Cengage Learning Testing, Powered by Cognero Page 65 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES b $4,20 c $4,41 d $4,63 e $4,862 ANSWER: RATIONALE: a Tax rate 40% Year 2009 2010 2011 2012 2013 2014 Taxable Income $ 50,000 $ 40,000 $ 30,000 $ 20,000 −$100,000 $ 60,000 Carry-Forward Used $0 $0 $0 $0 $0 $100,000 EBT After Forward Applied $50,000 $40,000 $30,000 $20,000 $0 $10,000 Unused Carryable Amount $0 $0 $0 $0 $100,000 $0 2014 Tax liability = EBT × Tax rate 2014 Tax liability = $4,000 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Carry-back, carry-forward Bloom’s: Analysis Multiple Choice: Problem 126 Moose Industries faces the following tax schedule: Tax on Base Percentage on Taxable Income of Bracket Excess above Base Up to $50,000 $0 15% $50,000−$75,000 7,500 25 $75,000−$100,000 13,750 34 $100,000−$335,000 22,250 39 $335,000−$10,000,000 113,900 34 $10,000,000−$15,000,000 3,400,000 35 $15,000,000−$18,333,333 5,150,000 38 Over $18,333,333 6,416,667 35 Last year the company realized $10,000,000 in operating income (EBIT) Its annual interest expense is $1,500,000 What was the company's net income for the year? a $4,809,87 b $5,063,02 Cengage Learning Testing, Powered by Cognero Page 66 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES c $5,329,50 d $5,610,00 e $5,890,50 ANSWER: RATIONALE: d Operating income Interest expense $10,000,000 $1,500,000 Taxable income = Operating income − Interest expense Taxable income = $10,000,000 − $1,500,000 Taxable income = $8,500,000 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667 % on Excess above Base 15% 25% 34% 39% 34% 35% 38% 35% Tax on base = $113,900 Tax on excess base = $2,776,100 Tax liability = $2,890,000 Net income = Taxable income − Taxes Net income = $5,610,000 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Net income Bloom’s: Analysis Multiple Choice: Problem 127 Corporations face the following tax schedule: Taxable Income Up to $50,000 $50,000−$75,000 $75,000−$100,000 $100,000−$335,000 $335,000−$10,000,000 $10,000,000−$15,000,000 Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 Cengage Learning Testing, Powered by Cognero Percentage on Excess above Base 15% 25 34 39 34 35 Page 67 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES $15,000,000−$18,333,333 5,150,000 38 Over $18,333,333 6,416,667 35 Company Z has $80,000 of taxable income from its operations, $5,000 of interest income, and $30,000 of dividend income from preferred stock it holds in other corporations What is Company Z's tax liability? a $17,328 b $18,240 c $19,20 d $20,210 e $21,221 ANSWER: d Taxable income $80,000 RATIONALE: Interest income Dividend income Dividend exclusion % $ 5,000 $30,000 70% Total taxable income = Taxable income + Interest income + Taxable dividend income Total taxable income = Taxable income + Interest income + Dividend income (1 − Dividend exclusion %) Total taxable income = $94,000 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667 % on Excess above Base 15% 25% 34% 39% 34% 35% 38% 35% Tax on base = $13,750 Tax on excess base = $6,460 Tax liability = $20,210 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Corporate taxes Bloom’s: Analysis Multiple Choice: Problem 128 Lintner Beverage Corp reported the following information from their financial statements: Operating income (EBIT) = $20,000,000 Interest payments on long-term debt = $1,750,000 Dividend income = $1,000,000 Cengage Learning Testing, Powered by Cognero Page 68 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES Calculate Lintner's total tax liability using the corporate tax schedule below: Tax on Base Taxable Income of Bracket $0−$50,000 $0 $50,000−$75,000 7,500 $75,000−$100,000 13,750 $100,000−$335,000 22,250 $335,000−$10,000,000 113,900 $10,000,000−$15,000,000 3,400,000 $15,000,000−$18,333,333 5,150,000 Over $18,333,333 6,416,667 a $6,167,875 b $6,492,50 c $6,817,125 d $7,157,98 e $7,515,881 ANSWER: b Operating income RATIONALE: Percentage on Excess above Base 15% 25 34 39 34 35 38 35 Interest payments Dividend income Dividend exclusion % $20,000,000 $ 1,750,000 $ 1,000,000 70% Taxable income = Operating income − Interest payments + Taxable dividend income Taxable income = Operating income − Interest payments + Dividend income × (1 − Dividend exclusion %) Taxable income = $18,550,000 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667 % on Excess above Base 15% 25% 34% 39% 34% 35% 38% 35% Tax on base = $6,416,667 Tax on excess base = $75,833 Tax liability = $6,492,500 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Cengage Learning Testing, Powered by Cognero Page 69 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES TOPICS: KEYWORDS: OTHER: Corporate taxes Bloom’s: Analysis Multiple Choice: Problem 129 Last year, Martyn Company had $500,000 in taxable income from its operations, $50,000 in interest income, and $100,000 in dividend income Using the corporate tax rate table given below, what was the company's tax liability for the year? Tax on Base Taxable Income of Bracket $0−$50,000 $0 $50,000−$75,000 7,500 $75,000−$100,000 13,750 $100,000−$335,000 22,250 $335,000−$10,000,000 113,900 $10,000,000−$15,000,000 3,400,000 $15,000,000−$18,333,333 5,150,000 Over $18,333,333 6,416,667 a $177,97 b $187,34 c $197,20 d $207,060 e $217,41 ANSWER: c Operating income RATIONALE: Percentage on Excess above Base 15% 25 34 39 34 35 38 35 Interest income Dividend income Dividend exclusion % $500,000 $ 50,000 $100,000 70% Taxable income = Operating income + Interest income + Taxable dividend income Taxable income = Operating income + Interest income + Dividend income × (1 − Dividend exclusion %) Taxable income = $580,000 Taxable Income $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 Tax on Base of Bracket $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667 % on Excess above Base 15% 25% 34% 39% 34% 35% 38% 35% Tax on base = $113,900 Tax on excess base = $83,300 Tax liability = $197,200 Cengage Learning Testing, Powered by Cognero Page 70 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Corporate taxes Bloom’s: Analysis Multiple Choice: Problem 130 Griffey Communications recently realized $125,000 in operating income The company had interest income of $25,000 and realized $70,000 in dividend income The company's interest expense was $40,000 Tax on Base Percentage on Taxable Income of Bracket Excess above Base Up to $50,000 $0 15% $50,000−$75,000 7,500 25 $75,000−$100,000 13,750 34 $100,000−$335,000 22,250 39 $335,000−$10,000,000 113,900 34 $10,000,000−$15,000,000 3,400,000 35 $15,000,000−$18,333,333 5,150,000 38 Over $18,333,333 6,416,667 35 Using the corporate tax schedule above, what is Griffey's tax liability? a $29,44 b $30,99 c $32,62 d $34,34 e $36,05 ANSWER: d Operating income $125,000 RATIONALE: Interest expense Interest income Dividend income Dividend exclusion % $ 40,000 $ 25,000 $ 70,000 70% Taxable income = Operating income − Interest expense + Interest income + Taxable dividend income Taxable income = Operating income − Interest expense + Interest income + Div income (1 − Div exclusion %) Total taxable income = $131,000 Taxable Income Cengage Learning Testing, Powered by Cognero Tax on Base of Bracket % on Excess above Base Page 71 CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES $0 $50,000 $75,000 $100,000 $335,000 $10,000,000 $15,000,000 $18,333,333 $0 7,500 13,750 22,250 113,900 3,400,000 5,150,000 6,416,667 15% 25% 34% 39% 34% 35% 38% 35% Tax on base = $22,250 Tax on excess base = $12,090 Tax liability = $34,340 POINTS: DIFFICULTY: REFERENCES: LEARNING OBJECTIVES: NATIONAL STANDARDS: STATE STANDARDS: TOPICS: KEYWORDS: OTHER: CHALLENGING 3-9 Income Taxes FOFM.BRIG.16.03.09 - Income taxes United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills United States - OH - DISC.FOFM.BRIG.16.05 - Financial analysis and cash flows United States - OH - DISC.FOFM.BRIG.16.06 - Finance function Corporate taxes Bloom’s: Analysis Multiple Choice: Problem Cengage Learning Testing, Powered by Cognero Page 72