Problem 1: The Shrieves Corporation has $10,000 that it plans to invest in marketable securities. It is choosing among AT&T Bonds, which yield 7.5%, state of Florida muni bonds, which yield 5%, and AT & T preferred stock , with a dividend yield of 6%. Shrieves' corporate tax is rate is 35%, and 70% of the dividends received are tax exempt.
Assuming that the investments are equally risky and that Shrieves chooses strictly on the basis of after-tax returns, which security should be selected? What is the after-tax rate of return on the highest yielding security?
Problem 2: The Menendez Corporation expects to have sales of $12 million. Costs other than depreciation are expected to be 75% of sales, and depreciation is expected to be 1.5 Million. All sales revenues will be collected in cash, and costs other than depreciation must be paid for during the year. Mendndez's federal-plus-state tax rate is 40%
A) Set up an income statement. What is Menendez's expected net cash flow?
B) Suppose congress changed the tax laws so that Menendez's depreciation expenses doubled. No changes in operations occurred. What would happen to reported profit and to net cash flow?
C) Now suppose that Congress instead of doubling Menendez's depreciation, reduced it by 50%. How would profit and net cash flow be affected?
D) If this were your company would you prefer Congress to cause your depreciation expense to be doubled or halved? Why?