Finance Solutions

PROBLEM SET 3 SOLUTIONS

Problem 1

Taxable income = operating income + interest received - interest paid + 30% of dividends received

= 300,000 + 15,000 - 35,000 + .30(30,000)

  = 289,000

Tax liability  = Tax on base + (tax rate)(excess over base)

= 22,250 + .39(289,000 - 100,000)

= 95,960

Problem 2

Note: Solution assumes the 3 year carry-back/15 year carry-forward rule

(a) Firm has no tax liability in 2010 since taxable income is negative

(b) Apply loss in current year to 3 prior years (starting with earliest

year which is 2007) until loss is eliminated

Note that 2006 is beyond the 3 year carry-back limit

And note the tax rate can be determined from the information given:

Tax rate = Tax paid/Taxable income in years 2006-2009 = 20%

Year 2006

  Taxable income was 2000

Tax paid was 400

Adjusted taxable income is 2000

Adjusted tax due is 400

Year 2007

Taxable income was 6250

Tax paid was 1250

Adjusted taxable income is 0

Adjusted tax due is 0

Year 2008

Taxable income was 12500

Tax paid was 2500

Adjusted taxable income is 0

Adjusted tax due is 0

Year 2009

Taxable income was 6250

Tax paid was 1250

Adjusted taxable income is 3750

Adjusted tax due is 750

Year 2010

Taxable income was (21250)

Tax paid was 0

Adjusted taxable income is 0

Adjusted tax due is 0

(c) Tax paid (2006-2009) = 400 + 1250 + 2500 + 1250 + 0 = 5400

Tax due  (2006-2009) = 400 +    0 +    0 +  750 + 0 = 1150

Tax refund = Tax paid – tax due = 5400 – 1150

= 4250

Problem 3 (Prob. 3-1)

Given: NI = 3,000,000

EBIT = 6,000,000

T = 40%

Need to set up an income statement and work from the bottom up:

EBIT 6,000,000

INT (1,000,000)

EBT 5,000,000

T (2,000,000)

NI 3,000,000

EBT = NI / (1 – T)

= 3,000,000 / 0.6

= 5,000,000

Interest = EBIT – EBT

= 6,000,000...