Principles of Finance ACST603
Tutorial 1, Week 1 Business organisations, taxation and financial statements
Homework questions.
The average weekly earnings of an Australian adult worker before tax was $1,542.40 per week in November 2014 according to the Australian Bureau of Statistics. Therefore average annual earnings before tax were $80,204.80 assuming 52 weeks per year. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below:
| Taxable income | Tax on this income |
|---|---|
| 0 – $18,200 | Nil |
| $18,201 – $37,000 | 19c for each $1 over $18,200 |
| $37,001 – $80,000 | $3,572 plus 32.5c for each $1 over $37,000 |
| $80,001 – $180,000 | $17,547 plus 37c for each $1 over $80,000 |
| $180,001 and over | $54,547 plus 45c for each $1 over $180,000 |
The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations
How much personal income tax would you have to pay per year if you earned $80,204.80 per annum before-tax?
In 2014 the median starting salaries of male and female Australian bachelor degree accounting graduates aged less than 25 years in their first full-time industry job was $50,000 before tax, according to Graduate Careers Australia. See page 9 of this report. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below.
| Taxable income | Tax on this income |
|---|---|
| 0 – $18,200 | Nil |
| $18,201 – $37,000 | 19c for each $1 over $18,200 |
| $37,001 – $80,000 | $3,572 plus 32.5c for each $1 over $37,000 |
| $80,001 – $180,000 | $17,547 plus 37c for each $1 over $80,000 |
| $180,001 and over | $54,547 plus 45c for each $1 over $180,000 |
The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations
How much personal income tax would you have to pay per year if you earned $50,000 per annum before-tax?
Question 449 personal tax on dividends, classical tax system
A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.
The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.
The United States' classical tax system applies because the company generates all of its income in the US and pays corporate tax to the Internal Revenue Service. The shareholder is also an American for tax purposes.
What will be the personal tax payable by the shareholder and the corporate tax payable by the company?
The corporate tax payable is very simple:
###\begin{aligned} \text{CorporateTaxPayable } &= \text{ProfitBeforeTax}.t_c \\ &= 100 \times 0.3 \\ &= 30 \\ \end{aligned}###Therefore the profit after tax is $70 and it's all paid as a fully franked dividend. The shareholder's personal tax payable will be:
###\begin{aligned} \text{PersonalTaxPayable } &= \text{CashDiv}.t_p \\ &= 70 \times 0.45 \\ &= 31.5 \\ \end{aligned}###Notice that the total tax payable is $61.5. The dividends were double-taxed at the corporate and personal level which is always the case in classical tax systems such as in the United States. Note however that in the US corporate and personal tax rates are lower than in Australia.
Question 448 franking credit, personal tax on dividends, imputation tax system
A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.
The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.
The Australian imputation tax system applies because the company generates all of its income in Australia and pays corporate tax to the Australian Tax Office. Therefore all of the company's dividends are fully franked. The sole shareholder is an Australian for tax purposes and can therefore use the franking credits to offset his personal income tax liability.
What will be the personal tax payable by the shareholder and the corporate tax payable by the company?
The corporate tax payable is very simple:
###\begin{aligned} \text{CorporateTaxPayable } &= \text{ProfitBeforeTax}.t_c \\ &= 100 \times 0.3 \\ &= 30 \\ \end{aligned}###Therefore the profit after tax is $70 and it's all paid as a fully franked dividend. The shareholder's personal tax payable will be:
###\begin{aligned} \text{PersonalTaxPayable } &= \text{GrossedUpDiv}.t_p - \text{FrankingCredit} \\ &= \dfrac{\text{CashDiv}}{1-t_c}.t_p - \dfrac{\text{CashDiv}}{1-t_c}.t_c \\ &= \dfrac{70}{1-0.3} \times 0.45 - \dfrac{70}{1-0.3} \times 0.3 \\ &= 45 - 30 \\ &= 15 \\ \end{aligned}###Notice that the total tax payable is $45, which is 45% of the original pre-tax earnings of the firm. This is the aim of the imputation system: for the sum of corporate and personal tax to equal the individual shareholder's personal marginal rate which in this case is 45%. This way dividends are not double-taxed as they are in classical tax systems such as in the United States.
Question 469 franking credit, personal tax on dividends, imputation tax system, no explanation
A firm pays a fully franked cash dividend of $70 to one of its Australian shareholders who has a personal marginal tax rate of 45%. The corporate tax rate is 30%.
What will be the shareholder's personal tax payable due to the dividend payment?
No explanation provided.
Question 494 franking credit, personal tax on dividends, imputation tax system
A firm pays a fully franked cash dividend of $100 to one of its Australian shareholders who has a personal marginal tax rate of 15%. The corporate tax rate is 30%.
What will be the shareholder's personal tax payable due to the dividend payment?
Question 624 franking credit, personal tax on dividends, imputation tax system, no explanation
Which of the following statements about Australian franking credits is NOT correct? Franking credits:
No explanation provided.
Question 443 corporate financial decision theory, investment decision, financing decision, working capital decision, payout policy
Business people make lots of important decisions. Which of the following is the most important long term decision?
The investment decision determines what assets to buy to carry on the business. If managers buy assets that fail to create enough revenue to cover costs then the business will eventually fail.
Question 444 investment decision, corporate financial decision theory
The investment decision primarily affects which part of a business?
The investment decision is about what assets the business should buy. Managers are supposed to buy assets that increase shareholder wealth. Buying undervalued assets is the best way to do this. The business project of buying the undervalued asset and then selling it for a higher price or using it to generate cash flow would be called a positive net present value (NPV) project.
Question 445 financing decision, corporate financial decision theory
The financing decision primarily affects which part of a business?
The financing decision is about how to finance the business's assets. If there isn't enough cash to buy assets, more cash must be raised by issuing liabilities such as loans, bills or bonds or by issuing shares.
Question 446 working capital decision, corporate financial decision theory
The working capital decision primarily affects which part of a business?
Working capital, also called net working capital (NWC), is the amount of current assets less current liabilities. Working capital decisions seek to manage these accounts to avoid insolvency which is when the business cannot pay its current liabilities when they're due.
Question 447 payout policy, corporate financial decision theory
Payout policy is most closely related to which part of a business?
Payout policy is about how much to pay shareholders and in what form, if anything at all.
The firm can distribute cash to shareholders in the form of dividends which are distributed to all, or buy backs (also called repurchases) where shareholders can elect to sell their shares back to the company which then cancels those shares.
The expression 'cash is king' emphasizes the importance of having enough cash to pay your short term debts to avoid bankruptcy. Which business decision is this expression most closely related to?
Cash is a current asset which is part of net working capital, whether it's in the bank or in notes and coins. The saying emphasizes how business managers need to keep a close eye on their net working capital. They need to make sure they have enough cash to cover their short term liabilities, or else the business will become bankrupt.
The expression 'you have to spend money to make money' relates to which business decision?
The saying 'you have to spend money to make money' alludes to the idea that you have to buy assets to generate income, which relates to the investment decision. Perhaps the saying would be better phrased as 'you have to invest money (in assets) to make money (generate income and capital gains)'.
Which of the following decisions relates to the current assets and current liabilities of the firm?
Working capital (also called net working capital) equals current assets less current liabilities.
###NWC = CA - CL###Current assets and liabilities lasts for less than one year, such as cash (CA) or inventory (CA) or accounts payable (CL). Non-current assets and liabilities last for more than one year such as PPE (NCA) or bond liabilities that will mature in 3 years (NCL).
Question 767 idiom, corporate financial decision theory, no explanation
The sayings "Don't cry over spilt milk", "Don't regret the things that you can't change" and "What's done is done" are most closely related to which financial concept?
No explanation provided.
Question 768 accounting terminology, book and market values, no explanation
Accountants and finance professionals have lots of names for the same things which can be quite confusing.
Which of the following groups of items are NOT synonyms?
No explanation provided.
Question 729 book and market values, balance sheet, no explanation
If a firm makes a profit and pays no dividends, which of the firm’s accounts will increase?
No explanation provided.
Question 737 financial statement, balance sheet, income statement
Where can a publicly listed firm's book value of equity be found? It can be sourced from the company's:
The book value of equity is what accountants record 'in the books' on the company's balance sheet. Listed companies must publish their balance sheet and other financial statements publicly, they can't keep them a secret the way private companies can.
Question 738 financial statement, balance sheet, income statement
Where can a private firm's market value of equity be found? It can be sourced from the company's:
Private companies are not publicly listed on the stock exchange. Therefore their shares do not trade every day on the open market. While private companies' shares can be bought and sold between private investors, typically this is rare. Private companies' shares are usually illiquid (hard to sell).
The market capitalisation of equity equals the share price multiplied by the number of shares. Given that the share price is usually unknown, the most common way to estimate the value of a private companies' market value of equity is to use multiples or discounted cash flow methods.
Question 531 bankruptcy or insolvency, capital structure, risk, limited liability
Who is most in danger of being personally bankrupt? Assume that all of their businesses' assets are highly liquid and can therefore be sold immediately.
Darren has negative equity in his business. His business equity is -$7,000 since the business's liabilities of $10,000 are greater than its assets of $3,000. Since the business is a sole tradership rather than a company, Darren is personally liable for the business's debts.
Darren's non-business personal assets of $10,000 less personal liabilities of $6,000 net to $4,000. Therefore Darren's total personal wealth including the business is -$3,000 (=4,000-7,000), so he is most in danger of going bankrupt when the business's liabilities have to be repaid.
Notice that Billy's business also has negative equity of -7,000 (=3,000-10,000) and therefore his company is in danger of going bankrupt when its debts are due. However, since the business is a company, Billy will not be personally liable for those debts. He won't have to pay them, unlike Darren whose business is not a company.
Question 524 risk, expected and historical returns, bankruptcy or insolvency, capital structure, corporate financial decision theory, limited liability
Which of the following statements is NOT correct?
Stocks are more risky than debt because in the event of bankruptcy, stock holders have a residual claim on the firm's assets and are only paid out if there's anything left over after the debt holders are paid. Debt holders have first claim on the firm's assets so in the event of bankruptcy they're paid out first and thus have a higher chance of being paid when the firm's assets are liquidated.
Firms' expected future stock returns are always higher than their expected future debt returns since stocks are more risky than debt and deserve a higher return.
However, firms' past realised stock returns can be higher or lower than their past realised debt returns. This is because the firm may have had a few bad years where profits were lower than expected and the share price fell, but the debt can still be repaid so its price stayed the same. In this case the past realised returns on the shares were negative, but the returns on debt were zero.
Which of the following statements about book and market equity is NOT correct?
The statement in answer C is untrue. A company's book value of equity is recorded in its balance sheet, also known as the statement of financial position.