Question

What impact would there be if the government raised the corporate tax rate from 21% to 28% on the Return on Common Equity (ROCE) for a firm with a net income of 208,000, preferred dividends of 12% of net income, beginning of year common equity of 1.2M and end of year common equity of 1.25M?

Once you determine the ROCE, explain whether you believe raising or not raising taxes would be beneficial.

Answer 1

The corpoarte tax is one of the fundametal of good economy. Every company expects to pay tax when they make income.

In thetwo situations we will use two different rates and will see the effect on ROCE:

There are opening and closing balances of the equity. In idal situation, we should always use weighted numbers. So, in this case, weighted equity is 1.225M as the simple average of opening and closing.

Net income = 208,000

Here we are assuming, dividend of preference shares is 12% fixed so it acts like a debt here in calculation.

Preference dividend = 12% * 208,000

= 24,960

Now, earnings pertaining to common equity = 208,000 - 24,960 = 183,040

1. At 21% corporate tax:-

Taxes = 21% * 183.040 = 0.21 * 183,040 = 38,438.4

Now the earnings available to common equity = 183,040 - 38,438.4 = 144,601.6

ROCE = (144,601.6/1225000)*100%

= (0.118)*100% = 11.8%

2. At 28% corporate tax:-

Taxes = 28% * 183,040 = 0.28 * 183,040 = 51,251.2

Now the earnings available to common equity = 183,040 - 51,251.2 = 131,788.8

ROCE = (131,788.8/1225000)*100%

= (0.108)*100% = 10.8%

So, as we can see there is fall in ROCE so increasing taxes is not beneficial.