Q5-17-21BP-a Question: The treasurer of Kelly... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 5: Q5-17-21BP-a (page 571)

Question: The treasurer of Kelly Bottling Company (a corporation) currently has $150,000 invested in preferred stock yielding 8 percent. He appreciates the tax advantages of preferred stock and is considering buying $150,000 more with borrowed funds. The cost of the borrowed funds is 13 percent. He suggests this proposal to his board of directors. They are somewhat concerned by the fact that the treasurer will be paying 5 percent more for funds than the company will be earning on the investment. Kelly Bottling is in a 35 percent tax bracket, with dividends taxed at 20 percent.
a. Compute the amount of the after-tax income from the additional preferred stock if it is purchased.

Short Answer

Expert verified

Answer

The after-tax income will be $11,280.

Step by step solution

Step-by-step solutionStep 1: Information provided in the question

Investment in preferred stock = $150,000

Preferred stock yield= 8%

Funds to be borrowed = $150,000

Tax rate = 35%

Dividend tax rate = 20%

Calculation of after-tax income

The after-tax income is $11,280.

$\begin{matrix} Dividend = Preferred stock amount 脳 Rate of dividend \\ = $ 150, 000 脳 8 % \\ = $ 12, 000 \end{matrix}$

$\begin{matrix} Tax liability = Taxable income 脳 Tax rate \\ = ($ 12, 000 脳 30 %) 脳 20 % \\ = $ 3, 600 脳 20 % \\ = $ 720 \end{matrix}$

$\begin{matrix} After - tax income = Dividend - Tax liability \\ = $ 12, 000 - (Taxable income 脳 Dividend tax rate) \\ = $ 12, 000 - $ 720 \\ = $ 11, 280 \end{matrix}$

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In \( millions	In \) millions
Current assets	\(70	Current liabilities	\)30
Fixed assets	\(70	Long-term liabilities	\)30
		Total liabilities	\(60
		Stockholder鈥檚 equity	\)80
Total assets	\(140	Total stockholder鈥檚 equity and liabilities	\)140

Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders鈥� equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder鈥檚 equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder鈥檚 equity	\)15,680,000
Total liabilities and stockholder鈥檚 equity	$28,650,000

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Short Answer

Step by step solution

Step-by-step solutionStep 1: Information provided in the question

Calculation of after-tax income

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