Reviewing one of my weaker topics, please post tid bits to help me [everyone] along.
MM - with taxes (minimize WACC and 100% debt) and without taxes (dividend are irrelevant and capital structure has no value)
Double taxation: Is the U.S. system where profits are taxed at a corporate level and then at a dividend level. Split rate tax system: A split rate system (Germany) taxes earnings to be distributed as dividends at a different rate then retained earnings. Corporate profits distributed as dividends are taxed at a lower rate than those retained in the business. It favors shareholders in a low tax bracket to prefer a higher payout, since distributed income is taxed less. Imputation system This system (UK, New Zealand) charges taxes at only a single level and taxes are taxed only at the shareholder rate. Taxes are paid at the corporate level but they are attributed to the shareholder. On their taxes, the shareholder would either pay an additional tax or receive a tax credit depending on their marginal tax rate relative to the corporate tax rate.
James Case and Erica Gallardo are considering differences between accounting income and economic income when evaluating capital projects. Case makes the following statements to Gallardo: Statement 1: One of the main reasons why accounting income and economic income will differ is that interest expense is subtracted when calculating accounting income, but is not considered when computing economic income. Statement 2: Another reason why accounting income and economic income may differ is that accounting depreciation is based on original costs while economic depreciation is based on market values. Gallardo considers both of Case’s statements. Gallardo would find which statements CORRECT? A) Neither are correct. B) Only one is correct. C) Both are correct.
c - both are correct
C
C
I’m long on MrGrey & cfaboston passing1 C was correct! Case has accurately described the two major differences between accounting income and economic income. Accounting depreciation is based on the original cost of an investment, while economic depreciation is based on the market value of the asset. Also, the interest expense that is subtracted from accounting income is not considered when computing economic income because interest expenses are implicit in the required rate of return used to calculate the asset’s market value.
B? Statement 1 is incorrect b/c interest expense IS considered when computing economic income b/c it’s included in WACC. Statement 2 is correct.
steph96 Wrote: ------------------------------------------------------- > B? > > Statement 1 is incorrect b/c interest expense IS > considered when computing economic income b/c it’s > included in WACC. > > Statement 2 is correct. Int exp is included in discounted rate (Wacc)
Paul Ulring, Chief Executive Officer of Arlington Machinery, has asked Sara Trafer about the benefits of using a variety of valuation models for evaluating capital projects. In response to Ulring’s questions, Trafer makes the following statements: Statement 1: The economic profit, residual income, and claims valuation methods of valuation should all result in the same valuation for an asset or project, despite the use of different discounts rates in the calculations. Statement 2: The claims valuation and economic profit valuation models both include cash flows that will flow to debt holders, and the cost of debt is a factor in both calculations. Which is CORRECT regarding Trafer’s statements? A) Both are correct. B) Both are incorrect. C) Only one is correct.
C
both correct. A?
I say A.
A was correct! Trafer’s first statement is correct. In theory, all three of the different valuation approaches should lead to the same result, despite the economic profit method using the WACC, the residual income method using the cost of equity, and the claims valuation approach separately using the cost of debt and cost of equity as discount rates. Trafer’s second statement is also correct. The claims valuation approach looks at cash flows to equity holders and debt holders separately, while the economic profit method looks at cash flows from the perspective of all suppliers of capital, so debt holders’ concerns are included in both methods. Also, the discount rate used with the economic profit method is the WACC, while the claims valuation approach considers the cost of equity and the cost of debt separately, so the cost of debt is a factor in both calculations
both are correct… a)
“The claims valuation and economic profit valuation models both include cash flows that will flow to debt holders” Ah, misread that “WILL FLOW”. Good question.
Business risk is the uncertainty regarding the operating income of a company. Financial risk refers to the uncertainty caused by the fixed cost associated with borrowed money.
also, BR = SR + OR
DOL = EBIT/Sales, Q (P-V)/Q(P-V) - F, S-TVC/S-TVC-F DFL = EPS/EBIT, EBIT/EBIT-Interest DTL = EPS/Sales, DOL * DFL Breakeven= F/P-V