Second time posted. Entire question not completed the first time posted. Please

Question

Second time posted. Entire question not completed the first time posted. Please answer ALL portions.

Interest versus dividend income During the year just ended, Shering Distributors,Inc., had pretax earnings from operations of $490,000. In addition, during the yearit received $20,000 in income from interest on bonds it held in Zig Manufacturing and received $20,000 in income from dividends on its 5% common stock holding in Tank Industries, Inc. Shering is in the 40% tax bracket and is eligible for a 70% dividend exclusion on its Tank Industries stock.

a. Calculate the firm’s tax on its operating earnings only.
b. Find the tax and the after-tax amount attributable to the interest income from
Zig Manufacturing bonds.
c. Find the tax and the after-tax amount attributable to the dividend income from
the Tank Industries, Inc., common stock.
d. Compare, contrast, and discuss the after-tax amounts resulting from the interest
income and dividend income calculated in parts b and c.
e. What is the firm’s total tax liability for the year?

Explanation / Answer

A.

Firms operating earnings = $490000

Firms tax on its operating earnings = 490000*40% = $196000

B.

Pretax amount of interest = $20000

Tax on interest = 20000*40% = $8000

After tax amount of interest = 20000-8000 = $12000

C.

Pretax amount of dividend = $20000

Tax on dividend = $20000- (70% of 20000) * 40%(since shering is eligible for 70% dividend exclusion)

Tax on dividend = $2400

After tax amount of dividend = $20000-$2400 = $17600

D.

The after tax amount resulting from interest income is $12000 and from dividend income is $17600. The dividend income is higher by $5600

These difference in dividend and interest income is due to shering inc. eligibility for 70% dividend exclusion on its income.

IF both security I.e. bond and common stock provides same rate of return then with no doubt it is beneficial to invest in common stock. However if there is difference in rate of return then if after tax interest rate on bond is higher than (17600*5/20000) 4.4% then investment should be done in bond. For example, if bonds pretax interest rate is 9% then after tax interest rate would be (9*60%) = 5.4% and since these rate is higher than 4.4% investment should be done in bonds

E.

Firms total tax liabiliy = $196000+$8000+$2400 = $206400

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