Elasticity Reveiw

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Problem Set 1 Solutions

1. Calculating Taxes. The Herrera Co. had $246,000 in taxable income. Using the rates from Table 2.3 in the chapter calculate the company's income taxes. What is the average tax rate? What is the marginal tax rate?

The total amount of income tax is
0.15($50,000 = $7,500
+ 0.25(($75,000 – 50,000)= $6,250
+ 0.34(($100,000 – 75,000)= $8,500
+ 0.39(($246,000 – 100,000) = $56,940
Total = $79,190

The average tax rate is the total amount of tax divided by taxable income, so:

Average tax rate = $79,190 / $246,000 = 0.3219 or 32.19%

The marginal tax rate is the tax rate on the next $1 of earnings (taxable income). Since taxable income of $246,000 falls in the 39% tax bracket, it is our marginal tax rate.

2. Calculating Net Capital Spending. Gordon Driving School's 2009 balance sheet showed net fixed assets of $1.65 million, and the 2010 balance sheet showed net fixed assets of $1.73 million. The company's 2010 income statement showed a depreciation expense of $284,000. What was Gordon’s net capital spending for 2010?

Net capital spending = (Ending NFA – Beginning NFA) + Depreciation
Net capital spending = $1,730,000 – 1,650,000 + 284,000
Net capital spending = $364,000

3. Building an Income Statement. During the year, the Senbet Discount Tire Company had gross sales of $1.2 million. The firm's cost of goods sold and selling expenses were $450,000 and $225,000, respectively. Senbet also had notes payable of $900,000. These notes carried an interest rate of 9 percent. Depreciation was $110,000. Senbet’s tax rate was 35 percent.

a. What was Senbet’s net income?

The interest expense for the company is the amount of debt (notes payable in this case) times the interest rate on the debt. Thus the amount of interest expense is $900,000(0.09 = $81,000.

So, the income statement for the company is:
Income Statement
Sales$1,200,000
– Cost of goods sold 450,000
– Selling costs225,000
– Depreciation 110,000
EBIT$415,000
– Interest 81,000
Taxable income$334,000
– Taxes 116,900
Net income$217,100

b. What was Senbet’s operating cash flow (OCF)?

OCF = EBIT + Depreciation – Taxes
OCF = $415,000 + 110,000 – 116,900 = $408,100

4. Calculating Total Cash Flows. Schwert Corp. shows the following information on its 2010 income statement: sales = $167,000; costs = $91,000; other expenses = $5,400; depreciation expense = $8,000; interest expense = $11,000; taxes = $18,060; dividends = $9,500. In addition, you’re told that the firm issued $7,250 in new equity during 2010 and redeemed $7,100 in outstanding long-term debt.

a. What is the 2010 operating cash flow (OCF)?

OCF = EBIT + Depreciation – Taxes

EBIT = (Sales – Costs – Other Expenses – Depreciation) =
= ($167,000 – 91,000 – 5,400 – 8,000) = $62,600

OCF = $62,600 + 8,000 – 18,060 = $52,540

b. What is the 2010 cash flow to creditors?

Cash Flow to Creditors = Interest – (Ending LT Debt – Beginning LT Debt)

Since the firm redeemed (paid off) $7,100 of long-term debt it means the amount of outstanding debt must decrease. Thus the ending value of long-term debt must be less than the beginning value of long-term debt by $7,100. In other words (Ending LT Debt – Beginning LT Debt) = –$7,100.

Cash Flow to Creditors (CFC) = $11,000 – (–$7,100) = $18,100

c. What is the 2010 cash flow to stockholders?

Cash Flow to Stockholders = Dividends – (Ending Common Equity – Beginning Common Equity)

Since the firm issued (raised new capital) $7,250 of new equity, it means the amount of outstanding common equity must increase. Thus the ending value of common equity must be more than the beginning value of common equity by $7,250. In other words (Ending Common Equity – Beginning Common Equity) = $7,250.

Cash Flow to Stockholders (CFS) = $9,500...
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