Fin355 Chapter 2 Answers

* What are the differences between the following components of taxable income? Provide at least one example of each.

* Corporations incur taxes at the corporate level at marginal rates; while, distributions to shareholders are taxed at dividend rate

In debt financing the interest expense is allowable expense resulting in low tax expense, where as in case of equity finance the cost of equity is dividend, and no advantage can be availed in tax.

Next comes “operating income”, which is revenues minus operating expenses, and generally referred to as EBIT, or earnings before income and taxes. In other words, this is a measurement of a company’s profits before all relevant deductions have been made. In our case, there was a significant increase of nearly 155 percent from year six to seven, and then another increase of over 60 percent in year seven to eight. The net earnings of Competition Bikes is up well over 300 percent for the first years of comparison, but declined over 80 percent between year seven and eight. This clearly indicates that factors have

Even further, allowing taxation treatments opposing equity and in favor of long-term debt steers considerable alterations in methods for financing assignments. Ideally, companies need to finance each business project per its pecuniary factors, rather than its tax factors. Yet, the disproportionate variance between effective tax percentages encourages companies to fund company projects using debt in lieu equity where possible.

The taxes are filed individually, instead of being double-taxed like the c-corporation, where the corporation pays taxes and then the individuals have to pay taxes

There is no fixed formula for the expression of legislative intent to give retrospectivity to a taxation enactment. Though the legislature has enormous powers to make retrospective taxing laws yet when the act is entirely arbitrary and irrational, it may be declared invalid as offending Article 14 of the Constitution. It is universally acknowledged that the most important feature of tax system is certainty. Investors base their decision on the current laws at the time of investment, although there is a scope for changes in laws , yet, they do not expect them to change retrospectively.

According to all the workings, the taxable income is calculated and provided in a table below.

business, you will not be obligated to pay taxes at a corporate level. Instead, the shareholders in

Assume you have just been hired as a business manager of PizzaPalace, a regional pizza restaurant chain. The company’s EBIT was $50 million last year and is not expected to grow. The firm is currently financed with all equity and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms’ owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm’s investment banker the following estimated

Although riskier, debt financing helps company have a better financial structure and because Blaine Kitchenware refuses to do so, we agree that their capital structure and pay out policies are not the most appropriate for the firm.

There are a number of reasons that a company would forgo debt financing in favor of equity. The first is that debt financing increases the risk of the company. The cash flows that the company earns are allocated to debt re-service first, which reduces the amount of funding available to help the company expand. Additionally, there may come covenants attached to the debt that further restrict the ability of management to perform its duties in the manner it would prefer. Thus, the debt's restrictions may cause management to undertake activities that are not in the best interest of the shareholders, simply because those activities are in the best interests of the creditors.

When corporate taxes are taken into consideration, the value of a firm increases linearly with debt-equity ratio because of interest payments being tax exempted. M-M’s work has been at the centre stage of the

(5) the return of equity is equal to the return on debt of a project/firm

If external financing is required, the “safest” securities, namely debt, are issued first. Although investors fear mispricing of both debt and equity, the fear is much greater for equity. Corporate debt still relatively little risk compared to equity because, if financial distress is avoided, investors receive a fixed return.. Thus, the pecking order theory implies that, if outside financing required, debt should be issued before equity. Only when the firm’s debt capacity is reached should the firm consider equity.