Question

Instructions: In this section, please show all calculations. Partial credit will be given wherever possible, when your calculations are shown and they are completed correctly.

33. – 35. Corporate Income Taxes

Corporate Tax Schedule

If Corporation's Taxable	It Pays This Amount on the	Plus this Percentage on the
Income is:	Base of the Bracket:	Excess Over the 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%

a. Assume that Eastwick Corporation realized a “Pre-Tax Income” of $12,500,000 in 2017.

1. What was Eastwick Corporation’s corporate tax liability for 2017?

2. What was Eastwick Corporation’s average income tax rate in 2017?

3. What was Eastwick Corporation’s marginal income tax rate in 2017?

b. Now, assume that Eastwick Corporation received an additional $50,000 of dividend income in 2017, in addition to the “Pre-Tax Income” of $12,500,000 noted in Part A above. What is the federal income tax liability applicable only to this additional $50,000 of dividend income?

36.—44. Ratio Analysis

Please see the Balance Sheet and Income Statement for Hennesaw Lumber, Inc. for the fiscal year ended December 31, 2017 below. Calculate the following ratios for 2017 for Hennesaw Lumber, Inc.:

Industry Average

a. Average Collection Period:   23 days

b. Debt Ratio:                               64.7%

c. Return on Equity (ROE): 8.2%

d. Current Ratio: 1.3

e. Inventory Turnover:                 21.7

f. Times Interest Earned (TIE):   4.8

g. Net Profit Margin: 1.0%

h. Return On Total Assets (ROA): 2.9%

Based on the ratios you have calculated above, does Hennesaw Lumber, Inc. appear to be stronger or weaker than the industry average data? Which specific ratios led you to this conclusion?

45.—47. Portfolio Analysis

Assume that you have just received information from your investment advisor that your portfolio has reached a value of $500,000. Your portfolio consists of three stocks, as follows:

Stock	Amount Invested	Beta
B	$175,000	1.25
D	$200,000	2.00
F	$125,000	.90
Total:	$500,000

a. Calculate the beta of this investment portfolio.

b. Assume that the expected market return ( r _m ) is 10 percent and the expected risk-free rate ( R_F ) is 3 percent. What is the expected return ( r _j ) for this investment portfolio?

              

48.—50. Statistical Analysis:

Assume that you have obtained the following information for Asset A:

Rate of Return	Probability
9%	30%
11%	15%
15%	55%

a. Compute the expected rate of return for Asset A, using the information provided in the chart above.

b. Given that the standard deviation for Asset A is 2.73%, compute the coefficient of variation.

	HENNESAW LUMBER, INC.
	Income Statement for Year Ended December 31, 2017
		-------------2017----------------
		DOLLARS	% OF SALES
Sales Revenue		4,200,000	100.00%
Cost of Goods Sold		3,570,000	85.00%
Gross Profit		630,000	15.00%
Depreciation Expense		210,000	5.00%
Operating Profits (EBIT)		420,000	10.00%
Interest Expense		105,000	2.50%
Profit Before Taxes		315,000	7.50%
Less: Taxes @ 40%		126,000	3.00%
Net Profit After Taxes		189,000	4.50%
	HENNESAW LUMBER, INC.
	Balance Sheet As of December 31 2017
		-------------2017----------------
		DOLLARS	% OF ASSETS
ASSETS:
Cash		25,000	2.65%
Accounts Receivable		120,000	12.70%
Inventories		300,000	31.75%
Total Current Assets		445,000	47.09%
Net Fixed Assets		500,000	52.91%
TOTAL ASSETS		945,000	100.00%
LIABILITIES AND EQUITY:
Accounts Payable		80,000	8.47%
Notes Payable		350,000	37.04%
Accruals		50,000	5.29%
Total Current Liabilities		480,000	50.79%
Long-Term Debt		150,000	15.87%
TOTAL LIABILITIES		630,000	66.67%
Common Stock		180,000	19.05%
Retained Earnings		135,000	14.29%
TOTAL STOCKHOLDERS' EQUITY		315,000	33.33%
TOTAL LIABILITIES AND EQUITY		945,000	100.00%

Answer 1

33. – 35. Corporate Income Taxes

a.

1) “Pre-Tax Income” of $12,500,000 falls in the 35% tax bracket.

So, their tax liability is

= 3,400,000 (for income between $10,000,000 -- $15,000,000 + 35% above the base)

= 3,400,000 + (12,500,000 - 10,000,000 * 0.35)

= 3,400,000 + 875,000

= $ 4,275,000

2) Eastwick Corporation’s average income tax rate

= Total tax liability (1)/Pre tax income

= 4,275,000/12,500,000*100

= 34.2%

3) Marginal tax rate for the company is 35% (Tax bracket between $10,000,000 -- $15,000,000)

b. Dividend tax rate

As per IRS, dividend can be treated as the ordinary income or long term capital gain.

Dividends can be taxed either at the ordinary income tax rates or at the preferred long-term capital gains tax rates.

Dividends that qualify for the lower long-term capital gains tax rates are called qualified dividends. They're taxed at rates of 0, 15 or 20 percent, depending on your tax bracket.

If you fall into the 10 or 15 percent tax bracket, your tax rate on dividends is zero. You must include the dividend income with your other income for purposes of determining your tax bracket. The 15 percent rate applies if you're in any of the 25 through 35 percent tax brackets, and you'll pay 20 percent on qualified dividends if you're in the 39.6 percent bracket.

Here, this company falls in the 35% tax bracket. So, it will pay 15% rate on the dividend income.

= $ 50,000 * 15%

= $ 7,500

36.—44. Ratio Analysis

Hennesaw Lumber, Inc. appear to be "weaker" based on the ratios. Current, Debt equity and Times interest earned ratio suggest that. Other ratios may be better than the industry, these three are the stability ratios which suggest that the company is not a stable since the company is mostly functional because of the debt and company does not have enough assets to pay off the debts.

Average Collection Period = No of days in a year / Account receivable ratio

= AR ratio = Net sales / Avg receivables = 4,200,000/120,000 = 35

= Average Collection Period = No of days in a year / Account receivable ratio

= 360/35

= 10.28 days. (Better than the industry average)

Debt Ratio = Total debt/Total equity

= 630000/315000

= 200%. (Worst than the industry average)

Return on Equity (ROE) = Net income / Total equity

= 189000/315000

= 60% (Excellent than the industry average)

Current Ratio = Current Asset / Current liability

= 445000/480000

= 0.9270 (Weaker than the industry average)

Inventory Turnover = COGS / Average Inventory

= 3,570,000 / 300,000

= 11.9 (Better than the industry)

Times Interest Earned (TIE) = (Interest Expense + Net income + Tax paid) / Interest Expense

= (189,000 + 126,000 + 105,000) / 105000

= 4 times (Weaker than industry)

Net Profit Margin = Net income / Sales

= 189,000 / 4,200,000

= 4.5 % (Better than the industry average)

Return On Total Assets (ROA) = Net income / Total assets

= 189000/945000

= 20 %.(Better than the industry average)

45.—47. Portfolio Analysis

a. Beta of this investment portfolio.

= (Amount in stock B/Total investment) * Beta of B +

(Amount in stock D/Total investment) * Beta of D +

(Amount in stock F/Total investment) * Beta of F

= (175000/500000) * 1.25 + (200000/500000) * 2 + (125000/500000) * 0.9

= 0.4375 + 0.8 + 0.225

= 1.4625

b. Expected return ( r j ) for this investment portfolio

= Rj = Rf + B(Rm - Rf)

= 3 + 1.4625(10 - 3)

= 3 + 10.2375

= 13.2375

48.—50. Statistical Analysis:

a. Expected rate of return of A

= Rate 1 * Probability + Rate 2 * Probability + Rate 3 * Probability

= 0.09*0.30 + 0.11*0.15 + 0.15*0.55

= 0.027 + 0.0165 + 0.0825

= 12.6%

b. Coefficient of variation

CV = Standard deviation / Expected return

= 2.73%/12.6%

= 21.67%.