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CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
114. For 2014, 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 10%, 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.
$1,670
b.
$1,758
c.
$1,850
d.
$1,943
e.
$2,040
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?
a.
All in the plant project.
b.
All in FPL preferred stock.
c.
60% in the project; 40% in FPL.
d.
60% in FPL; 40% in the project.
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 40%, 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.
7.80%
b.
8.00%
c.
8.20%
d.
8.41%
e.
8.62%
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 8.5% (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?
a.
35.39%
b.
37.25%
c.
39.22%
d.
41.18%
e.
43.24%
OTHER:
Multiple Choice: Problem
118. Mantle Corporation is considering two equally risky investments:
∙
A $5,000 investment in preferred stock that yields 7%.
∙
A $5,000 investment in a corporate bond that yields 10%.
What is the break-even corporate tax rate that makes the company indifferent between the two investments?
a.
34.27%
b.
36.08%
c.
37.97%
d.
39.87%
e.
41.87%
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
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 35%. What is the
after-tax return on the best investment alternative? (Assume the company chooses on the basis of after-tax returns.)
a.
8.500%
b.
8.925%
c.
9.371%
d.
9.840%
e.
10.332%
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 25%. What is the after-tax return on the best investment alternative?
a.
7.383%
b.
7.772%
c.
8.181%
d.
8.612%
e.
9.065%
121. Collins Co. began operations in 2011. 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 is summarized below:
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
Year
EBT
2011
−$3,000,000
2012
−$5,200,000
2013
$4,200,000
2014
$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 2011. What is Collins' tax
liability for 2014?
a.
$1,069,848
b.
$1,188,720
c.
$1,320,800
d.
$1,462,000
e.
$1,617,200
122. Salinger Software was founded in 2011. The company lost money each of its first three years, but was able to turn a
profit in 2014. Salinger's operating income (EBIT) for its first four years of operations is reported below.
Year
EBIT
2011
−$ 50,000,000
2012
−$150,000,000
2013
−$100,000,000
2014
$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 2011. How much tax did the company pay in 2014?
a.
$114,030,875
b.
$120,032,500
c.
$126,350,000
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
d.
$133,000,000
e.
$140,000,000
123. Bradshaw Beverages began operations in 2010. The table below contains the company's taxable income during each
year of its operations. Notice that the company lost money in each of its first three years. The corporate tax rate has been
40% each year.
Year
Taxable Income
2010
−$ 700,000
2011
−$ 500,000
2012
−$ 200,000
2013
$ 800,000
2014
$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 2010. How much did the company pay in taxes during 2014?
a.
$160,000
b.
$168,000
c.
$176,400
d.
$185,220
e.
$194,481
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
124. Uniontown Books began operating in 2010. 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
2010
−$3,600,000
2011
−$2,000,000
2012
−$1,000,000
2013
$1,200,000
2014
$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 2014? (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 2010.)
a.
$466,412
b.
$490,960
c.
$516,800
d.
$544,000
e.
$571,200
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
125. Mays Industries was established in 2009. Since its inception, the company has generated the following levels of
taxable income (EBT):
Year
Taxable Income
2009
$ 50,000
2010
$ 40,000
2011
$ 30,000
2012
$ 20,000
2013
−$100,000
2014
$ 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 2008. What is the company's tax liability for 2014?
a.
$4,000
b.
$4,200
c.
$4,410
d.
$4,631
e.
$4,862
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
126. Moose Industries faces the following tax schedule:
Tax on Base
Percentage on
Taxable Income
of Bracket
Excess above 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
Last year the company realized $10,000,000 in operating income (EBIT). Its annual interest expense is $1,500,000. What
was the company's net income for the year?
a.
$4,809,874
b.
$5,063,025
c.
$5,329,500
d.
$5,610,000
e.
$5,890,500
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
127. Corporations face the following tax schedule:
Tax on Base
Percentage on
Taxable Income
of Bracket
Excess above 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
Company Z has $80,000 of taxable income from its operations, $5,000 of interest income, and $30,000 of dividend
income from preferred stock it holds in other corporations. What is Company Z's tax liability?
a.
$17,328
b.
$18,240
c.
$19,200
d.
$20,210
e.
$21,221
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
128. Lintner Beverage Corp. reported the following information from their financial statements:
Operating income (EBIT) = $20,000,000
Interest payments on long-term debt = $1,750,000
Dividend income = $1,000,000
Calculate Lintner's total tax liability using the corporate tax schedule below:
Tax on Base
Percentage on
Taxable Income
of Bracket
Excess above Base
$0−$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.
$6,167,875
b.
$6,492,500
c.
$6,817,125
d.
$7,157,982
e.
$7,515,881
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
129. Last year, Martyn Company had $500,000 in taxable income from its operations, $50,000 in interest income, and
$100,000 in dividend income. Using the corporate tax rate table given below, what was the company's tax liability for the
year?
Tax on Base
Percentage on
Taxable Income
of Bracket
Excess above Base
$0−$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.
$177,973
b.
$187,340
c.
$197,200
d.
$207,060
e.
$217,413
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
130. Griffey Communications recently realized $125,000 in operating income. The company had interest income of
$25,000 and realized $70,000 in dividend income. The company's interest expense was $40,000.
Tax on Base
Percentage on
Taxable Income
of Bracket
Excess above 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
Using the corporate tax schedule above, what is Griffey's tax liability?
a.
$29,442
b.
$30,992
c.
$32,623
d.
$34,340
e.
$36,057
CHAPTER 03—FINANCIAL STATEMENTS, CASH FLOW, AND TAXES
