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Chapter 03: Financial Statements, Cash Flow, and Taxes
b.
4.80%
c.
6.15%
d.
6.28%
e.
6.22%
110. Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds
and U.S. Treasury bonds. Both have the same maturity, and they are equally risky and liquid. If Treasury bonds yield 6%,
and Carter’s marginal income tax rate is 24.00%, what yield on the Chicago municipal bonds would make Carter’s
treasurer indifferent between the two?
a.
4.47%
b.
5.43%
c.
4.56%
d.
5.61%
e.
5.20%
Chapter 03: Financial Statements, Cash Flow, and Taxes
111. A 5-year corporate bond yields 8.00%. A 5-year municipal bond of equal risk yields 6.5%. Assume that the state tax
rate is zero. At what federal tax rate are you indifferent between the two bonds? (Round your final answer to two decimal
places.)
a.
18.94%
b.
21.00%
c.
20.25%
d.
21.38%
e.
18.75%
Chapter 03: Financial Statements, Cash Flow, and Taxes
112. Last year, Stewart-Stern Inc. reported $11,250 of sales, $4,500 of operating costs other than depreciation, and $1,250
of depreciation. The company had $3,500 of bonds outstanding that carry a 6.5% interest rate, and its federal-plus-state
income tax rate was 35%. During last year, the firm had expenditures on fixed assets and net operating working capital
that totaled $2,000. These expenditures were necessary for it to sustain operations and generate future sales and cash
flows. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase
by $1,300. By how much will the depreciation change cause (1) the firm's net income and (2) its free cash flow to change?
Note that the company uses the same depreciation for tax and stockholder reporting purposes. Do not round the
intermediate calculations.
Net Income
Free Cash Flow
a.
-$845.00; $455.00
b.
-$971.75; $559.65
c.
-$828.10; $473.20
d.
-$887.25; $445.90
e.
-$718.25; $427.70
Chapter 03: Financial Statements, Cash Flow, and Taxes
113. Watson Oil recently reported (in millions) $8,250 of sales, $5,750 of operating costs other than depreciation, and
$650 of depreciation. The company had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-
state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm
was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net operating working
capital. By how much did the firm's net income exceed its free cash flow? Do not round the intermediate calculations.
a.
$708
b.
$796
c.
$907
d.
$669
e.
$653
Chapter 03: Financial Statements, Cash Flow, and Taxes
114. For 2015, Bargain Basement Stores reported $11,500 of sales and $5,000 of operating costs (including depreciation).
The company has $20,500 of total invested capital, the weighted average cost of that capital (the WACC) was 14%, and
the federal-plus-state income tax rate was 40%. What was the firm's Economic Value Added (EVA), i.e., how much value
did management add to stockholders' wealth during 2014?
a.
$927
b.
$979
c.
$1,236
d.
$876
e.
$1,030
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?
(Round your final answer to two decimal places.)
a.
All in FPL preferred stock.
b.
60% in FPL; 40% in the project.
c.
All in the plant project.
d.
60% in the project; 40% in FPL.
e.
50% in each.
Chapter 03: Financial Statements, Cash Flow, and Taxes
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 29.00%, 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.
8.22%
b.
6.41%
c.
7.56%
d.
8.71%
e.
8.46%
Chapter 03: Financial Statements, Cash Flow, and Taxes
117. A corporation can earn 7.5% if it invests in municipal bonds. The corporation can also earn 8.35% (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? Assume a 70% dividend exclusion for tax on
dividends. (Do not round your intermediate answer and round your final answer to two decimal places.)
a.
29.52%
b.
36.31%
c.
33.93%
d.
29.18%
e.
30.54%
118. Mantle Corporation is considering two equally risky investments:
∙ A $5,000 investment in preferred stock that yields 6.45%.
Chapter 03: Financial Statements, Cash Flow, and Taxes
∙ A $5,000 investment in a corporate bond that yields 10%.
What is the breakeven corporate tax rate that makes the company indifferent between the two investments? Assume a
70% dividend exclusion for tax on dividends. (Do not round your intermediate answer and round your final answer to two
decimal places.)
a.
46.22%
b.
38.30%
c.
33.01%
d.
44.02%
e.
50.18%
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 37.00%. What is the
after-tax return on the best investment alternative? Assume a 70% dividend exclusion for tax on dividends. (Assume the
company chooses on the basis of after-tax returns. Round your final answer to 3 decimal places.)
a.
7.055%
b.
9.010%
c.
6.545%
d.
8.500%
e.
9.775%
Chapter 03: Financial Statements, Cash Flow, and Taxes
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 16.00%. What is the after-tax return on the best investment alternative? Assume a 70%
dividend exclusion for tax on dividends. (Round your final answer to 3 decimal places.)
a.
9.870%
b.
10.956%
c.
8.883%
d.
10.660%
e.
10.857%
Chapter 03: Financial Statements, Cash Flow, and Taxes
121. Collins Co. began operations in 2012. 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 are summarized below:
Year
EBT
2012
-$5,250,000
2013
-$5,200,000
2014
$4,200,000
2015
$8,300,000
The corporate tax rate has remained at 34%. 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 2012. What is Collins’ tax
liability for 2015?
a.
$676,090
b.
$780,640
c.
$634,270
d.
$850,340
e.
$697,000
Chapter 03: Financial Statements, Cash Flow, and Taxes
122. Salinger Software was founded in 2012. The company lost money each of its first three years, but was able to turn a
profit in 2015. Salinger’s operating income (EBIT) for its first four years of operations is reported below.
Year
EBIT
2012
-$200,000,000
2013
-$150,000,000
2014
-$100,000,000
2015
$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 2012. How much tax did the company pay in 2015?
a.
$103,250,000
b.
$106,750,000
c.
$72,625,000
d.
$87,500,000
e.
$94,500,000
Chapter 03: Financial Statements, Cash Flow, and Taxes
123. Bradshaw Beverages began operations in 2011. 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.
Year
Taxable Income
2011
-$600,000
2012
-$500,000
2013
-$200,000
2014
$800,000
2015
$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 2011. How much did the company pay in taxes during 2015?
a.
$206,000
b.
$200,000
c.
$202,000
Chapter 03: Financial Statements, Cash Flow, and Taxes
d.
$196,000
e.
$168,000
124. Uniontown Books began operating in 2011. 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
2011
-$3,200,000
2012
-$2,000,000
2013
-$1,000,000
2014
$1,200,000
2015
$7,000,000
The company has no debt, and therefore, pays no interest expense. Its corporate tax rate has remained at 34% during this
5-year period. What was Uniontown’s tax liability for 2015? (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 2011.)
a.
$646,000
b.
$686,800
c.
$700,400
Chapter 03: Financial Statements, Cash Flow, and Taxes
d.
$680,000
e.
$802,400
125. Mays Industries was established in 2010. Since its inception, the company has generated the following levels of
taxable income (EBT):
Year
Taxable Income
2010
$50,000
2011
$40,000
2012
$30,000
2013
$20,000
2014
-$50,000
2015
$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 2010. What is the company’s tax liability for 2015?
a.
$24,960
b.
$24,480
c.
$24,000
