Question

Kraftstoff is a​ German-based company that manufactures electronic​ fuel-injection carburetor assemblies for several large automobile companies in​ Germany, including​ Mercedes, BMW, and Opel. The​ firm, like many firms in Germany​ today, is revising its financial policies in line with the increasing degree of disclosure required by firms if they wish to list their shares publicly in or out of Germany.

​Kraftstoff's primary problem is that the German corporate income tax code applies a different income tax rate to income depending on whether it is retained ​(40​%) or distributed to stockholders ​(32​%). The​ company's earnings before tax​ (EBT) is euro€485,500,000.

a. If Kraftstoff planned to distribute​ 50% of its net​ income, what would be its total net income and total corporate tax​ bills?

b. If Kraftstoff was attempting to choose between a​ 40% and​ 60% payout rate to​ stockholders, what arguments and values would management use in order to convince stockholders which of the two payouts is in​ everyone's best​ interest?

a. If Kraftstoff planned to distribute​ 50% of its net​ income, calculate its total net income and toatl corporate tax bills in the following​ table:  ​(Round to the nearest whole​ euro.)

Kraftstoff's Income Items		50% payout
Earnings before taxes (EBT)	€	485,500,000
Less income taxes at 32%
Net income	€
Distributed income	€
Less added distributed income taxes		0
After-tax distributed income	€
Retained income	€
Less added retained income taxes
After-tax retained income	€
Total after-tax net income	€
Total income taxes	€

Answer 1

Answer (a)-

	Amount	Tax rate	Tax liability	Net distribution
EBT	485,500,000
50% Distributed	242,750,000	32%	77,680,000	165,070,000 (Amount - Tax)
50% Retained	242,750,000	40%	97,100,000
Total net income after tax & distribution	145,650,000 (Amount - Tax)		174,780,000

(b)- 40% Distribution

		Tax rate	Tax Liability	Net distribution
EBT	485,500,000
40% Distributed	194,200,000	32%	62,144,000	132,056,000
60% Retained	291,300,000	40%	116,520,000
Total net income after tax & distribution	174,780,000		178,664,000

60% Distribution

		Tax rate	Tax liability	Net distribution
EBT	485,500,000
60% Distributed	291,300,000	32%	93,216,000	198,084,000
40% Retained	194,200,000	40%	77,680,000
Total net income after tax & distribution	116,520,000		170,896,000

Lower distribution is better if rate of return on equity is greater than investor return, otherwise higher is suggested.