Question

You invest $8,000 in an on-line bookstore in the form of a corporation on Jan. 2. For the sake of simplicity, you are the only shareholder who owns this corporation. You also decide to take on $10,000 liabilities with 20% annual interest rate. You spend $6,000 cash to buy books as the inventory. Throughout the year, you sell half of books to students in exchange for $9,000 cash, that is, your revenue is $9,000 and COGS is $3,000. Also, $2,000 cash dividend is paid at the end of the year. Tax rate is 40%.

All entries of balance sheet are zero at the beginning of the year (Jan. 1).

What is the equity value at the end of the year?

Answer 1

Calculation of Equity Value at the End of the Year:

a. Income Statement for the period:

Revenue    $9,000

Less: COGS    $3,000

Earnings Before Interest and Tax $6,000

Less: Interest Paid $2,000

($10,000 * 20%)                

Taxable Income    $4,000

Less: Tax @ 40% $1,600

(40% of Taxable Income of $4,000)                

Net Income    $2,400

Less: Cash Dividend Paid $2,000

Retained Earnings $400

b. Equity Value at the End of the Year = Initial Investment + Retained Earnings = $8,000 + $400 = $8,400