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Today’s Agenda

Today’s Agenda. Wrap up Chapter 3 and Appendix 3A Personal Income Taxes Taxation of Investment Income MVA and EVA Chapter 4: Ratio Analysis. 2006 Single Individual Tax Rates Note: Appendix 3A provides 2004 brackets. Taxable Income. Tax on Base. Rate*. 0 – 7,550. 0. 10%. 7,550 - 30,650.

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Today’s Agenda

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  1. Today’s Agenda • Wrap up Chapter 3 and Appendix 3A • Personal Income Taxes • Taxation of Investment Income • MVA and EVA • Chapter 4: Ratio Analysis

  2. 2006 Single Individual Tax RatesNote: Appendix 3A provides 2004 brackets. Taxable Income Tax on Base Rate* 0 – 7,550 0 10% 7,550 - 30,650 755.00 15% 30,650 - 74,200 4,220.00 25% 74,200 - 154,800 15,107.50 28% 154,800 - 336,550 Over 336,550 37,675.50 97.653.00 33% 35% O *Plus this percentage on the amount over the bracket base.

  3. Personal Income Taxes • Marginal tax rate = the tax rate on the next dollar of income. • Wages, tips, and interest income are considered ordinary taxable income. • Deductions: charitable donations, mortgage interest, a portion of student loan interest, personal exemptions, and medical expenses to an extent(> 7.5% of gross income).

  4. Personal Investment Taxes • Interest Income taxed at individual’s marginal tax rate. • Dividend Income tax rate: 15% or less • Financial and Real assets held for less than 12 MONTHS and then sold for a gain are considered short-term capital gains and taxed at the taxpayer’s marginal tax rate. • Long-term (held more than 12 months) capital gains are taxed at a max rate of 15%.

  5. Taxable vs. Tax Exempt Bonds State and local government bonds (munis) are generally exempt from federal taxes.

  6. After-tax Investment Returns • After-tax Return=Before-tax Return(1-T) • After-tax Corporate Dividend Return = Before-tax Dividend Yield (1 - .3T) • Municipal Bond Interest is tax exempt on the federal level • Equivalent pretax return = Muni Return/(1-T)

  7. After-Tax Return Example • Which of the following would you prefer if your marginal tax rate is 28%? • Exxon bonds at 10% or California municipal bonds at 7%. • At what marginal tax rate would you be indifferent be these two bonds?

  8. Example Solution

  9. MVA and EVA • Market Value Added (MVA) = Market value of common equity – book value of common equity • Feb 2006 for Best Buy: MV of common equity = $26.60 billion, book value of common equity = $5.25 billion • Feb 2006 Best Buy MVA = $26.6 – $5.25 = $21.35 billion • Economic Value Added (EVA) = NOPAT – Annual dollar cost of capital = true economic profit for a given period • EVA = EBIT(1-T) – [Total investor supplied operating capital x After-tax percentage cost of capital]

  10. Best Buy’s 2006 EVA (millions) • Let’s assume Best Buy’s tax rate is 35% and after-tax cost of capital is 17%. • EVA = EBIT(1-T) – AT cost of capital x capital • Investor supplied capital = current portion of long-term debt + long-term debt + total equity =5853 • EBIT = EBT + Interest paid = 1737 • EVA = 1737(1-.35) – 0.17(5853) = 134.04 • EVA Break-even cost of capital = 1737(1-.35)/5853 = 19.3%

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