[SoCalCPA]

Thanks for answering it in advance!

Q1) BooCorp, consulting firm was engaged by Tur corp to provide support for making investment decisions. Tur was in the process of buying Bay, its competitor. BooCorp’s financial analyst made an independent detailed analysis of Bay’s average collection period to determine which of the following?

a. financing

b. return on equity

c. liquidity

A1) Liquidity. Given that this is M&A, I figured liquidity is important but I don’t fully understand why liquidity is actually the answer.

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Q2) The benefits of debt financing over equity financing are likely to be highest in which of the following situations?

A2) High marginal tax rates and few noninterest tax benefits

With debt, higher the tax rates, the better it is due to tax benefits. But what is “noninterest tax benefits” referring to?

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Q3) James is the manager of Industrial Division, and his performance is measured using the residual income method. James is reviewing the following forecasted info for his division next year.

Working Capital- $1,800,000

Revenue – $30,000,000

Plant and Equip – $17,200,000

If the imputed interest charge is 15% and Webb wants to achieve a residual income target of $2 mill, what will costs have to be in order to achieve the target?

A3) $25,150,000 costs to achieve the target of $2 million.

I know that I have to add the working capital & PPE together to get the asset base of $19 million, then multiply by the hurdle rate to get hurdle income of $2,850,000. Then, I add that to the residual income target to get $4,850,000.

But, I don’t really understand the next relationship where we subtract the revenue ($30mil) by the target income ($4.850mil) to get the answer. Anyone understand that relationship?

Thanks again!

B - (4/2012)
A - (5/2012)
R - (1/2012) Done!
F - (10/2011) Done!

[Excited_CPA]

Q1) BooCorp, consulting firm was engaged by Tur corp to provide support for making investment decisions. Tur was in the process of buying Bay, its competitor. BooCorp's financial analyst made an independent detailed analysis of Bay's average collection period to determine which of the following?

-Average Collection Period tells you how quickly Bay can collect on their AR, and get cash. The higher it is, the more liquid (the better ability they have to convert assets into cash).

-Financing here doesn't really make sense since (this is how I reasoned it to myself) you're not really getting money from Debt or Equity financing.

-ROE here doesn't really make sense since it doesn't talk about income or Equity.

BEC 04/14/12 87
FAR 08/28/12 88
AUD 10/06/12 94
REG 02/09/13 91

[Excited_CPA]

Q2) The benefits of debt financing over equity financing are likely to be highest in which of the following situations?

A2) High marginal tax rates and few noninterest tax benefits

With debt, higher the tax rates, the better it is due to tax benefits. But what is “noninterest tax benefits” referring to?

Noninterest tax benefits refer to tax benefits you get for anything other than from paying interest, like DRD, CCD, etc. This is how I thought of it. “If the ONLY tax benefit that was offered on the tax return was for the interest you paid, then obviously it'll be better to use debt financing. But what if there was no tax benefits at all for interest paid, but only for everything else? In that case, there's less benefit of using debt financing since it's not cheaper than equity financing anymore.”

BEC 04/14/12 87
FAR 08/28/12 88
AUD 10/06/12 94
REG 02/09/13 91

[Excited_CPA]

Q3) James is the manager of Industrial Division, and his performance is measured using the residual income method. James is reviewing the following forecasted info for his division next year.

Working Capital- $1,800,000

Revenue – $30,000,000

Plant and Equip – $17,200,000

If the imputed interest charge is 15% and Webb wants to achieve a residual income target of $2 mill, what will costs have to be in order to achieve the target?

The question is asking what the costs need to be to achieve a target residual income target of $2 million.

Residual Income = Income – Hurdle Income

Income = Revenue – Cost

Revenue = 30 million

Residual Income = 2 million

You found out the hurdle income is $2,850,000.

2 million = (30 million – Cost) – 2,850,000

And then from that, you solve for the cost. Hope it helps!

And sorry for the triple post lol, I just wanted to focus on one question at a time.

When's your exam? I finished reviewing Finance, Cost, and am finishing up Economics right now. Just have to redo chapter 6, Corporate Governance, and IT MCQs.

Good luck!

BEC 04/14/12 87
FAR 08/28/12 88
AUD 10/06/12 94
REG 02/09/13 91

[SoCalCPA]

@Excited_CPA, thanks so much, I'm so happy that you are answering my questions haha. I should have figured it out, but I think my brain was pretty much after studying all day lol. My exam is next Friday, 4/6. My work schedule has been nuts, and so I'm only on B3… lol!

You are almost done reviewing twice, and your test is on April 14th? Wow congrats!! I am sure that you will be able to score in the 90s at this pace, good luck! Thanks again, I really appreciate your help.

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I am still unsure on the “few noninterest tax benefits part.” Again, obviously if tax rates are high, go with debt financing. But why does it matter if there are many or few noninterest tax benefits (like DRD as you mentioned).

B - (4/2012)
A - (5/2012)
R - (1/2012) Done!
F - (10/2011) Done!

[StellaFL]

Regarding “few noninterest tax benefits:

How about this: If there were a whole bunch of other tax benefits available to the corporation (domestic production activities deduciton, charitable contributions, dividends received deduction, accelerated depreciation, etc), then the tax benefit from the interest paid on the debt may not seem terribly important.

But if the interest deduction was the only tax benefit available, or there were only a few other “non interest” tax benefits, now it's very important, and bolsters the case even more to use debt, rather than equity, financing. Kind of like when you're starving, and a hamburger is put in front of you, it seems like the best thing in the world and you would do anything to eat it. But when you're not that hungry, becausee you've had a bunch of other food, now that hamburger isn't so great anymore.

I'm taking BEC on Wednesday. Very nervous about this one, don't feel quite as prepared as I did for REG, but I'm scoring in the 80s and 90s on Wiley Test Bank. We shall see. Good luck!

REG 11/28/11 - 88
BEC 04/04/12 - 88
FAR 07/23/12 - 90
AUD 11/2012 - 92

Yaeger/Wiley

[SoCalCPA]

Thanks Stella. Good luck to you as well 🙂 I'm still about half way through and mine is on the 6th, so I will help you with the curve haha.

B - (4/2012)
A - (5/2012)
R - (1/2012) Done!
F - (10/2011) Done!

[Author]

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