Fin 517 Ch. 15 Notes Debt and Taxes 15.1 The Interest Tax Deduction 1. interest tax shield – additional amount that a firm would have paid in taxes if it did not have leverage. Interest tax shield = corporate tax return X interest payments 2. because interest expense is tax deductible, leverage increases the total amount of income available to all investors 15.2 Valuing the Interest Tax Shield 1. when a firm uses debt, the interest tax shield provides a corporate tax benefit each year. 2. Because the cash flows of the levered firm are equal to the sum of the cash flows from the unlevered firm plus the interest tax shield, by the Law of One Price the same must be true for the present values of these cash flows.
P5; The Trading Account; The trading account is an account that shows profits and losses for a business. There are three parts to the trading account, the first one is sales turnover and this is the money that is coming into the business by trading. The formula for sales turnover is quantity sold x the selling price. According to business alpha the sales turnover for this business is 3,057,000. The second component is the cost of sales which includes the costs directly linked to providing the trade.
In this section I will look more closely at what creates a competitive advantage between market competitors towards customers at the same competitive level. J Sainsbury appears have solid financial position which is reflected in the grew of 7.1% of the sales and the £738m of Underlying operating profit that up raised 10.0% in 2011. (Sainsbury, 2011). However Dave McCarthy, an analyst at Evolution Securities affirm that Sainsbury’s remains the most susceptible supermarket because they have both the weakest cash flow and the weakest margin in the industry of groceries (Financial times, 2011). Considering that the net cash from operating activities is reduced 18% in 2011, which can affect their aims to expand.
It also has strategies to invest in value stocks, which have high book-to-market ratio and constantly outperformed growth stocks. DFA considers itself as a passive manager because in general DFA sold shares only if a stock no longer fit the portfolio it was in- if a small stock became large, or a value stock became a growth stock. So the constant change of the portfolio structure can be considered as one passive aspect of its strategy whereas precisely matching the holdings of the index portfolio would require DFA to buy discounted stocks in large blocks in which DFA’s traders took several steps to minimize the likelihood that they were being sold a lemon. 2) Who are DFA’s clients, and what are their concerns? What new clients is DFA trying to serve, and what are some of the new issues DFA will face in meeting these clients’ needs?
2. I utilized an “Acid Test Ratio” which shows us whether the entity could pay all its current liabilities if they became due now or sooner than expected. In 2011, the acid test ratio was 0.64. By 2012, it decreased to 0.43. Even though the acid-test ratio is less than 1 which rates in the lower third quartile in the industry of 1.6, 0.9 to 0.6, it indicates a concern with repaying current liabilities.
If the sales outlook for the coming three years was only 20,000,000 and B.E. continued producing at the rate of 30,000,000 units, a total of 10,000,000 units would be dumped into ending inventory at the end of each year once again reducing costs of goods sold and falsely increasing income. By the end of year 2013, B.E. Company would have 35,000,000 units sitting in ending inventory taking up space and costing money to store. Once again if the president’s bonus is based off of net income, this situation is the most favorable for a high paying bonus and encourages stockpiling inventory to inflate net income.
This calculates how much of the business is financed through private investors; it is also expressed in percentage form. Generally speaking, as a firm's debt-to-equity ratio increases, it becomes more risky because if it becomes unable to meet its debt obligations, it will be forced into bankruptcy. (Glakas) Of the three companies, Wal-Mart has the lowest total debt ratio (.62) as well as the lowest overall debt to equity ratio (1.65). Target finds itself with similar footing at .65 and 1.89 respectively, however Kroger has over 80% of its operations (.81) financed with debt and has the worst three year average when it comes to debt to equity with 4.40 times.
“We intend to retain our earnings to finance the expansion of our business and do not anticipate paying cash dividends in the foreseeable future……Dividend Payments are restricted by our bank credit facilities to 50% of our net income for the immediately preceding fiscal year.”i Cash Flow Statement Analysis: Krispy Kreme uses the Indirect Method of reporting Operating Cash Flows. In 2001 the cash provided by operating activities was $32,112 (Thousand), while the Cash dividends was $7,005 (Thousand). Cash provided by operating activities exceeded the cash paid for dividends. The company did not
b. Most sinking funds require the issuer to provide funds to a trustee, who holds the money so that it will be available to pay off bondholders when the bonds mature. c. A sinking fund provision makes a bond more risky to investors at the time of issuance. d. Sinking fund provisions never require companies to retire their debt; they only establish “targets” for the company to reduce its debt over time. e. If interest rates increase after a company has issued bonds with a sinking fund, the company will be less likely to buy bonds on the open market to meet its sinking fund obligation and more likely to call them in at the sinking fund call price.
The stock valuation model, P0 = D1/ (i - g), can be used for firms which have negative growth rates. 4. Company J and Company K each recently reported the same earnings per share (EPS). Company J’s stock, however, trades at a higher price. Which of the following statements is most correct?