Chapter 1, Problem 1
A) Calculate the tax disadvantage to organizing a U.S. business today as a corporation, as compared to a partnership, under the following conditions. Assume that all earnings will be paid out as cash dividends. Operating income (operating profit before taxes) will be $500,000 per year under either organizational form. The tax rate on corporate profits is 35% (= 0.35), the average personal tax rate for the partners is also 35%, and the capital gains tax rate on dividend income is 15% (= 0.15).
As a partnership the $500,000 will only be taxed one time, so $500,000 x (1-0.35) = $325,000. As a corporation the $500,000 will be taxed two times at corporate level and personal level, so $500,000 x (1-0.35) (1-0.15) = $276,250. The difference is $48,750 less in a corporation.
B) Now recalculate the tax disadvantage using the same income but with the maximum tax rates that existed before 2003. These rates were 35% on corporate profits and 38.6% (= 0.386) on personal investment income.
As a partnership before 2003 partners would receive $500,000 x (1-0.386) = $ 307,000. As a corporation before 2003 again it would be taxed twice (corporate and personal levels) so they would receive $500,000 x (1-o.35) (1-0.386) = $199,550. The difference is that corporate receives $107,450 less.
Chapter 2, Problem 2
Given the balance sheets and selected data from the income statement of SMG Industries that follow, answer parts a-c.
A) Calculate the firm’s operating cash flow (OCF) for the year ended December 31, 2012, using equation 2.2
OCF = EBIT – Taxes + Depreciation
4,500 - $1,300 + 1,600 = $4,800
B) Calculate the firm’s free cash flow (FCF) for the year ended December 31, 2012 using equations 2.4
OCF – FA (CA- A/P – Accruals)
4,800 – (31,500 – 30,100) – [(16,200 – 14,800) – 3,600 – 3,500) – (1,200- 1,300)] = $2,000
C) Interpret, compare,