Chapter 3 Lecture Notes

Question 1

Free Cash Flow

Answer 1

the cash flow actually available for distribution to all investors (stockholders and debtholders) after the company has made all the investments in fixed assets, new products, and working capital necessary to sustain ongoing operations

Question 2

FCF equation

Answer 2

EBIT(1-T) + Depreciation - (Change in FA + D) - Change in CA + (Change in AP +Accr)

Question 3

Operating Cash Flow Equation

Answer 3

EBIT(1-T) + D

Question 4

Gross Fixed Asset Equation

Answer 4

Change in FA + D

Question 5

Market Value Added

Answer 5

Shareholder wealth is maximized by maximizing the cumulative difference between the market value of the firms equity and the amount of equity capital that was supplied by investors

Question 6

MVA equation

Answer 6

(shares outstanding)(stock price) - total common equity

Question 7

Total Common Equity

Answer 7

APIC + Common Stock

Question 8

Can MVA be negative?

Answer 8

Yes

Question 9

Economic Value Added

Answer 9

focuses on a firm’s managerial effectiveness in a specific year

Question 10

EVA equation

Answer 10

EBIT(1-T) - Dep + Equity - (AP + Accr)

Question 11

After-Tax Operating Profit

Answer 11

EBIT(1-T)

Question 12

After-Tax Cost of Capital

Answer 12

Dep. + Equity -(AP + Accr) (WACC)

Question 13

Total capital

Answer 13

Debt + Equity

Question 14

How is EVA useful?

Answer 14

VERY STRONG CORRELATION BETWEEN EVA AND A FIRM’S STOCK PRICE
good measure of addition to shareholder value
can be used for divisions as well as for entire company
provides useful basis for determining managerial compensation
if EVA is positive, the ROE exceeds cost of equity

Question 15

What did the Tax Cuts & Jobs Act (2018) change the Corporate Tax Rate to?

Answer 15

A flat 21%

Question 16

Average Tax Rate equation

Answer 16

tax/EBT

Question 17

Taxable Income

Answer 17

EBT

Question 18

Healthcare Tax

Answer 18

3.8% if >$250k taxable income (married, joint)

Question 19

How is interest income taxed?

Answer 19

Taxed as ordinary income

Question 20

Alternative Minimum Tax (AMT)

Answer 20

Individuals must calculate their tax 2 ways and pay the higher amount
Brackets are indexed as of 2018

Question 21

What did TC&J do to AMT?

Answer 21

Got rid of AMT for corporations, but kept for individuals to allow room for inflation

Question 22

Municipal Bonds/”Munis”

Answer 22

States, cities, and counties

Not subject to federal income taxes

Question 23

What is the benefit of Munis?

Answer 23

Allows you to borrow money at a lower cost than what a corporation can do

Question 24

After Tax Yield equation

Answer 24

ATY = BTY(1-T)

Question 25

Capital Gain

Answer 25

Made when a capital asset is sold for more than its purchase price

Question 26

Capital Loss

Answer 26

Made when a capital asset is sold for less than its purchase price

Question 27

Short-Term Capital Gain/Loss

Answer 27

Sold within one year | Taxed as ordinary income

Question 28

Long-Term Capital Gain/Loss

Answer 28

Held for 1 year or longer Capped at 15% (Except for people in the lowest and the highest bracket)

Question 29

Dividend Income

Answer 29

Same caps for capital gains/losses (only since 2003)

Question 30

Invest to get dividends or capital gains?

Answer 30

Rates support capital gains

Question 31

Why would you tax capital gains differently?

Answer 31

Calmer, more sure way of flow of money, healthy for economy (both parties support this)

Question 32

Excess Capital Loss

Answer 32

Can offset $3,000 of other income

Question 33

Inherited Asset

Answer 33

Stepped-up basis | If kids sell the inherited asset, the new cost basis is the amount that it was worth when their person died

Question 34

Capital Assets

Answer 34

Stocks, bonds, and real estate

Question 35

Estate Tax

Answer 35

Doubled to $10 million without being taxed by the TC&J Act

Question 36

Mortgage Interest

Answer 36

Deductible on up to $750,000 of principal: not deductible on home equity loans anymore