Question

Builtrite had sales of $700,000 and COGS of $280,000. In addition, operating expenses were calculated at 25% of sales. Builtrite also received dividends of $50,000 and paid out common stock dividends of $25,000 to its stockholders. A long-term capital gain of $70,000 was realized during the year along with a capital loss of $50,000.

1. What is Builtrite’s taxable income?

2. Based on their taxable income, what is Builtrite’s tax liability?

3. If we add to our problem that Builtrite also had $10,000 in interest expense, which of the following statements is correct (assuming the same marginal tax rate of 39%)?

•Taxable income would increase by $10,000

•Taxable income would decrease by $10,000.

•Taxable income would decrease by $6,100.

•Taxable income would increase by $6,100

4. If Builtrite had experienced a long-term capital loss of $80,000 (instead of the $50,000 long-term capital loss stated in the problem), and still had the $70,000 long-term capital gain stated in the problem, which of the following is correct:

•taxable income would decrease by $30,000

•taxable income would not change

•taxable income would decrease by $10,000

•taxable income would decrease by $20,000

5. (This problem is not related to the above problem) Last year Builtrite had retained earnings of $150,000. This year, Builtrite had true net profits after taxes of $80,000 and also paid a preferred dividend of $20,000. What is Builtrite’s new level of retained earnings?

Answer 1

Question 1:

Sales = $700,000

COGS = $280,000

Operating Expense = $700,000 × 25%= $175,000

EBIT = $700,000 - $280,000 - $175,000

= $245,000

EBIT of company is $245,000.

70% of corporate dividend income is exempted from tax.

Taxable dividend payment = $50,000 × 30%

= $15,000.

Net Capital gain = $70,000 - $50,000 = $20,000.

Total Taxable income = $245,000 + $15,000 - $20,000

= $280,000

Total Taxable income is $280,000.

Question 2:

Taxable Income = $280,000

Tax Liability of company as follows

Tax liability = 22,250+(280000-100000)*39%  

= $92,450

Question 3:

Interest payment on debt is an expense for a company. So company can deduct interest payment on debt from taxable income. So, because of interest payment on debt total taxable income reduces.

Builtrite have $10,000 in interest expense then taxable income will decrease by $10,000.

Option (B) is correct answer

Question 4:

If Builtrite is having long term capital loss of $80,000 then he can setoff $70000 loss against long term capital gain of $70,000 and remaining loss of $10,000 can be carried forward to next years.

Therefore earlier Builrite could setoff only $50,000 as long term capital loss was $50,000. Now he can setoff loss of $70000 against long term capital gain of $70,000

Therefore taxable income would decrease by = $70,000 - $50,000 = $20,000

Hence 4th option is correct.