Question

Hemingway Corporation is considering expanding its operations to boost its income, but before making a final decision, it has asked you to calculate the corporate tax consequences of its decision. Currently, Hemingway generates before-tax yearly income of $200,000 and has no debt outstanding. Expanding operations would allow Hemingway to increase before-tax yearly income to $350,000. Hemingway can use either cash reserves or debt to finance its expansion. If Hemingway uses debt, it will have yearly interest expense of $70,000
Create a spreadsheet to conduct a tax analysis for Hemingway Corporation and determine the following:

a. What is Hemingway’s current annual corporate tax liability?

b. What is Hemingway’s current average tax rate?

c. If Hemingway finances its expansion using cash reserves, what will be its new corporate tax liability and average tax rate?

d. If Hemingway finances its expansion using debt, what will be its new corporate tax liability and average tax rate?

e. What would you recommend that the firm do? Why? Principles of Managerial Finance 15th Ed Zutter Smart Chapter 2

Answer 1

Answer:

Please see the answer below.

Explanation:

Given the information from the question.  According to Kartik solution that is found on chegg for this problem. Please see the following solution  

“a. Current annual corporate tax liability can be found using the corporate tax rate schedule:

Before tax income $ 200,000

Tax liability ($22,250 + $39,000) $61,250

b. Current average tax rate = $61,250 / $200,000 = 30.63%

c. If Hemingway finances its expansion using cash reserves, the new corporate tax liability and average tax rate is as under, using the corporate tax rate schedule:

Before tax income $ 350,000

Tax liability ($113,900 + $5,100) $ 119,000

Average tax rate = $119,000/$350,000 = 34%

d. If Hemingway finances its expansion using debt, the new corporate tax liability and average tax rate is as under, using the corporate tax rate schedule:

Before tax income $ 350,000

less: Interest expense ($ 70,000)

Taxable income $ 280,000

Tax liability ($22,250 + $70,200) $ 92,450

Average tax rate = $92,450/$280,000 = 33.02%

e. The after tax income from each possibility given below should be considered & the choice with the highest after tax income should be recommended:

Current after tax income = $200,000 - $61,250 = $138,750

Expansion with cash reserve, after tax income = $350,000 - $119,000 = $231,000

Expansion with debt, after tax income = $280,000 - $92,450 + $70,000 = $257,550

Hence, the third option with $257,550 after tax income is recommended”

Reference:  

Kartik : https://www.chegg.com/homework-help/questions-and-answers/hemingway-corporation-considering-expanding-operations-boost-income-making-final-decision--q32169475)