Unit 6: Tax Planning for Financial Management Decisions - Practice Quiz

1 What does a company's capital structure primarily represent?

2 Which payment made to providers of debt finance is generally considered for a tax deduction while calculating business income?

3 What is the tax shield associated with debt financing?

4 Which source of finance normally creates a fixed obligation to pay interest?

5 What is a dividend?

6 Which body generally recommends the final dividend of a company?

7 What does a stable dividend policy aim to provide?

8 What usually happens to retained earnings when a company pays a cash dividend?

9 What is a bonus share?

10 Bonus shares are generally issued in proportion to a shareholder's existing:

11 Which company account is commonly capitalized when bonus shares are issued?

12 Does a shareholder normally pay cash to receive bonus shares?

13 What is a tax-exempt investment?

14 Which factor should be considered when comparing taxable and tax-exempt investments?

15 If an investment earns income of and tax of is payable, what is the post-tax income?

16 Why is the timing of an investment relevant to tax planning?

17 What is a capital gain?

18 Which of the following is commonly treated as a capital asset?

19 A capital loss generally occurs when a capital asset is transferred for:

20 The distinction between short-term and long-term capital gains is primarily based on the asset's:

21 A company borrows $10,000,000 at an annual interest rate of 10%. If its corporate tax rate is 30% and the interest is fully deductible, what is the annual interest tax shield?

22 A company needs $4,000,000. It can either issue 200,000 shares, increasing total shares to 600,000, or borrow the amount at 10%, leaving 400,000 shares outstanding. If EBIT is $1,200,000 and the tax rate is 30%, what is EPS under the two plans?

23 A firm's financing consists of 40% debt and 60% equity. The pre-tax cost of debt is 8%, the cost of equity is 14%, and the corporate tax rate is 25%. What is its after-tax weighted average cost of capital?

24 A company is comparing debt carrying 9% interest with preference shares carrying an 8% dividend. The corporate tax rate is 25%, interest is deductible, and preference dividends are not deductible. Which source has the lower after-tax financing cost?

25 A company follows a residual dividend policy. It earns $5,000,000 and plans capital expenditure of $6,000,000. Its target financing mix is 60% equity and 40% debt. How much can it distribute as dividends without issuing new equity?

26 A shareholder can receive $100 through either a cash dividend or a share buyback. Dividends are taxed at 20%. Under the buyback, the shareholder's cost basis is $40 and the resulting capital gain is taxed at 10%. Ignoring transaction costs, which alternative gives the higher after-tax cash?

27 A shareholder faces a 30% tax on current dividends but a 15% tax on capital gains that is payable only when shares are sold. Assuming the company has acceptable investment opportunities, which policy is generally more tax-efficient for this shareholder?

28 A company with 500,000 outstanding shares declares a cash dividend of $2 per share. Ignoring taxes and market reactions, what is the immediate accounting effect of the payment?

29 A shareholder owns 800 shares before a 1-for-4 bonus issue. How many bonus shares will the shareholder receive, and what will be the total holding afterward?

30 A company's shares trade at $150 immediately before a 1-for-2 bonus issue. Assuming no change in total market capitalization, what should be the theoretical ex-bonus price per share?

31 An investor owns 600 shares purchased for $90 each and receives a 1-for-2 bonus issue. Under a tax rule that assigns a nil cost basis to bonus shares, what is the capital gain if 200 bonus shares are sold for $75 each?

32 A company has authorized capital of 1,000,000 shares and 900,000 shares already issued. It proposes a 1-for-3 bonus issue. What change is required before issuing the bonus shares?

33 A company can invest in a taxable bond yielding 9% or a tax-exempt bond yielding 6.8%. If the company's tax rate is 30% and the investments have equal risk, which investment provides the higher after-tax return?

34 A company purchases equipment for $500,000 and depreciates it evenly over five years with no residual value. If the tax rate is 30%, what is the annual depreciation tax shield?

35 A project costs $1,000,000 and generates annual cash earnings before depreciation and tax of $400,000 for five years. Annual depreciation is $200,000, the tax rate is 25%, and the five-year annuity factor at the required return is 3.17. What is the project's approximate NPV?

36 A company can claim a $400,000 tax deduction either immediately or one year later. Its tax rate is 30% and discount rate is 10%. What is the approximate present-value advantage of claiming the deduction immediately?

37 A company sells an investment for $1,200,000 and pays selling expenses of $20,000. The investment's tax cost basis is $700,000. What is the taxable capital gain?

38 An asset purchased for $500,000 is sold for $800,000. If the applicable price index was 300 at purchase and 360 at sale, what is the indexed capital gain, assuming indexation is permitted?

39 A company has a short-term capital gain of $120,000 and a long-term capital loss of $50,000. Under an assumed rule that long-term capital losses may be offset only against long-term capital gains, what amount is currently taxable?

40 An investment has a tax basis of $500,000. It can be sold now for $700,000 with the gain taxed at 30%, or in one year for $680,000 with the gain taxed at 15%. If the discount rate is 10%, which choice provides the higher present value of after-tax sale proceeds?

41 A company has EBIT of million, and its corporate tax rate is . It is considering issuing million of debt at an annual interest rate of to repurchase equity. Assume the debt does not increase expected financial distress costs. What is the annual tax shield from the new debt?

42 A corporation has EBIT of million and an existing interest expense of million. The tax rate is , and interest deductions are limited to of EBIT. If the company incurs an additional million of interest, what is the immediate tax benefit of the additional interest, assuming disallowed interest cannot be carried forward?

43 A company is choosing between issuing debt or preferred shares to raise million. Debt carries an annual interest rate of , while preferred shares require a dividend. The corporate tax rate is , and preferred dividends are not deductible. Ignoring issuance costs, which financing source has the lower annual after-tax cost?

44 A corporation has taxable income before financing costs of million. It may issue million of debt at interest. Interest is deductible only up to of EBIT, and excess interest can be carried forward indefinitely. The tax rate is . What is the current-year tax shield and the amount of interest carried forward?

45 A corporation has current earnings of million and plans capital expenditure of million. It targets a debt-to-total-capital ratio of and follows a residual dividend policy. Assuming capital expenditure is financed according to the target ratio, what dividend can be paid without issuing new equity?

46 A shareholder receives a cash dividend of per share. The dividend is taxed at , while capital gains are taxed at . If the shareholder can instead receive an economically equivalent share-price appreciation, what is the after-tax amount under each alternative, ignoring timing effects?

47 A corporation has 1 million shares outstanding, earnings of million, and a target payout ratio of . It plans a -for- stock split before declaring the dividend. What total dividend should be declared, and what dividend per post-split share will result?

48 A company has distributable cash of million and wishes to maintain its target capital structure. It needs million of equity financing for approved projects. It can either pay a dividend and issue new equity or retain earnings and avoid issuance costs. If issuing equity costs of the funds raised, what is the maximum dividend that avoids external equity issuance?

49 A company has 2 million shares with a par value of and a market price of . It issues a 1-for-2 bonus share capitalization from retained earnings. Ignoring market frictions, what are the post-bonus share count and theoretical market price per share?

50 A corporation capitalizes million of retained earnings through a 25\% bonus issue. Before the issue, it has 4 million shares outstanding with a market price of . Assuming the bonus issue does not change total market capitalization, what is the theoretical ex-bonus price?

51 A company has 5 million shares outstanding and announces a 3-for-5 bonus issue. An investor owns 20,000 shares before the issue. What will be the investor's holding after the issue, and what is the investor's proportional ownership if no shares are sold?

52 A company issues bonus shares by capitalizing retained earnings. For tax purposes, assume the bonus issue itself is not taxable to the shareholder, but it reduces the shareholder's per-share basis while preserving total basis. An investor owns 1,000 shares with a total basis of and receives 500 bonus shares. What is the basis per share after the issue?

53 A corporation is comparing two mutually exclusive investments. Project A requires million and has an after-tax NPV of million. Project B requires million and has an after-tax NPV of million. If capital is rationed to million and projects cannot be scaled, which choice maximizes value?

54 A corporation purchases equipment for million. It qualifies for immediate tax depreciation, while the equipment's accounting depreciation is irrelevant to tax. The corporate tax rate is . What is the initial tax effect of the immediate tax depreciation, ignoring tax-loss limitations?

55 A company is evaluating a project requiring an initial outlay of million. It generates annual pre-tax cash inflows of million for three years, with no salvage value. Tax depreciation of million is available immediately, the tax rate is , and the discount rate is . Ignoring working capital, what is the project's approximate NPV?

56 A corporation buys a bond for and receives interest during the year. At year-end, the bond is worth but remains unsold. Assume interest is taxed at and unrealized gains are not taxed. What is the year's after-tax investment income?

57 A corporation sells an investment asset for million. Its adjusted tax basis is million, selling costs are million, and the applicable capital-gains tax rate is . What is the after-tax capital gain?

58 A corporation realizes a short-term capital gain of and a capital loss of on another asset during the same tax year. Assume losses may fully offset gains and the applicable tax rate is . What is the net capital-gains tax?

59 An investor purchased shares for million and sells them for million. Brokerage fees are on purchase and on sale. If both fees adjust the tax basis or proceeds and the capital-gains rate is , what is the capital-gains tax?

60 A corporation owns land with a tax basis of million and a market value of million. It can sell the land and pay a 25\% capital-gains tax, or retain it. Ignoring time value, transaction costs, and future appreciation, what is the tax cost embedded in the asset if sold immediately?