Question

PDQ, Inc., expects EBIT to be approximately $14.8 million per year for the foreseeable future, and it has 100,000 20-year, 8 percent annual coupon bonds outstanding. (Use Table 11.1)

What would the appropriate tax rate be for use in the calculation of the debt component of PDQ’s WACC? (Round your answer to 2 decimal places.)

Tax rate

%

Answer 1

Tax rate to use is the average tax rate.

Average tax rate = tax expense / taxable income.

Taxable income = EBIT - interest expense

interest expense = bonds outstanding * face value per bond * coupon rate

interest expense = 100,000 * $1,000 * 8% = $8,000,000.

Taxable income = EBIT - interest expense

Taxable income = $14,800,000 - $8,000,000

Taxable income = $6,800,000.

Tax expense is calculated as below :

(($50,000 - $0) * 15%) + (($75,000 - $50,001) * 25%) + (($100,000 - $75,001) * 34%) + (($335,000 - $100,001) * 39%) + (($6,800,000 - $335,001) * 34%)

Tax expense = $2,311,998.68

Average tax rate =  $2,311,998.68 / $6,800,000.

Average tax rate = 34.00%