CHAPTER 1 The Role of Financial Management

Q 1. Explain what is the appropriate goal of the firm and why alternative goals are inappropriate. Q 2. Explain how the typical corporate firm is organized as it relates to the financial management function.

CHAPTER 1 The Business, Tax, and Financial Environments

Q 1. Last year Sweet Stuff Candy Corporation earned $172,000 before interest and taxes. The firm
paid $22,000 in interest charges and $48,000 in dividends. a. What is its taxable income? b. What is its tax liability? Ans. EBT = EBIT - I = $172,000 - $22,000 = $150,000 (taxable income). Note that dividends paid are from AFTER TAX earnings. Tax liability of $150,000 is $22,250 + .39 ($50,000 additional income) = $22,250 + $19,500 = $41,750 tax liability.

Q 2. In 2001 Quick Quilters Corporation earned $350,000 before taxes from operations. They
received an additional $8,000 in cash dividends from a minor stock investment in National Needles a. b. c. d. What's the effective tax rate on this additional dividend income What amount of tax do they owe on the dividend income? Calculate the after-tax dividend income from their investment. Suppose that Kasper owned 50% of National Needles. What would the after-tax dividend income be now?

Ans. $8,000 dividends x 70% exclusion = $2,400 taxable dividend income. $350,000 + $2,400 dividends = $352,400 (taxable income). This amount of earnings from operations puts the firm in the 34% marginal bracket. 34% x $2,400 = $816 tax on dividend income or only 10.2% of the original dividend income. AT dividend income = $8,000 - $816 = $7,184. At 50% tax rate: .20 x 34% x $8,000 = $544 tax on dividend income AT dividend income = $8,000 - $544 = $7,456. Refer to the footnote that indicates that only 20% of the dividends are taxable when a firm owns more than 20% of the stock.

Q 3. Travelsite.com Travel Services was incorporated in 1998. It had taxable income as follows:
1998 1999 2000 2001 2002 -$200,000 $100,000 $150,000 $300,000 -$150,000 What was Travelsite's tax payment or tax refund for each of the years? (Assume that the graduated tax rates discussed in your text apply to years 1998-2002.) Ans. 1998: Loss, so no taxes are owed. Carry forward up to 20 years. 1999: $100,000 less $100,000 of losses from 1998 = $0 taxable income and no taxes. 2000: $150,000 less $100,000 remaining losses of 1999 = $50,000 taxable income. This is $7,500 of taxes paid. Note: all tax losses from 1998 are totally used. 2001: $300,000 taxable income. This is $22,250 + .39(200,000) = $100,250 of taxes paid. 2002: -$150,000 taxable LOSS. This can be carried back to 2000 ($50,000) and 2001 ($100,000) = $7,500 tax refund from 2000 and $39,000 from 2001 for a total refund = $46,500.