Question

In 2018, Beta Corporation earned gross profits of $760,000.

a. Suppose that Beta was financed by a combination of common stock and $1 million of debt. The interest rate on the debt was 10%, and the corporate tax rate in 2018 was 21%. How much profit was available for common stockholders after payment of interest and corporate taxes? (Do not round intermediate calculations. Enter your answer in dollars not millions and round your answer to the nearest whole dollar amount.)

b. Now suppose that instead of issuing debt, Beta was financed by a combination of common stock and $1 million of preferred stock. The dividend yield on the preferred was 8%, and the corporate tax rate was still 21%. Recalculate the profit available for common stockholders after payment of preferred dividends and corporate taxes. (Do not round intermediate calculations. Enter your answer in dollars not millions and round your answer to the nearest whole dollar amount.)

Answer 1

Solution A	Scenario:1 million Debt
Gross Profit	760000
Interest on Debt (These are tax deductible expense. They are paid from net income before tax therefore tax advantage.)	100000	=1000000*10%
Net Profit	660000	=760000-100000
Corporate Tax Rate	138600	=660000*21%
Net Profit after Interest and corporate tax available to common stockholder ($)	521400	=660000-138600
Solution B	Scenario:1 million Preferred Stock
Gross Profit	760000
Interest on Debt	0
Net Profit	760000	=760000-0
Corporate Tax Rate	159600	=760000*21%
Net Profit after Interest and corporate tax	600400	=760000-159600
Preferred Dividend( These are not tax deductible expense. They are paid from net income after tax therefore no tax advantage.)	80000	=1000000*8%
Net Profit Available to common stock holder ($)	520400	=600400-80000