Today’s Agenda
1
 Wrap up Chapter 3 and Appendix 3A
 Personal Income Taxes
 Taxation of Investment Income
 MVA and EVA
 Chapter 4: Ratio Analysis
2006 Single Individual Tax Rates
Note: Appendix 3A provides 2004 brackets.
2
Taxable Income
0 – 7,550
7,550 - 30,650
30,650 - 74,200
74,200 - 154,800
154,800 - 336,550
Over O336,550
Tax on Base
Rate*
0
755.00
4,220.00
15,107.50
37,675.50
97.653.00
10%
15%
25%
28%
33%
35%
*Plus this percentage on the amount over the
bracket base.
Personal Income Taxes
3
 Marginal tax rate = the tax rate on the next dollar of
income.
 Wages, tips, and interest income are considered
ordinary taxable income.
 Deductions: charitable donations, mortgage interest,
a portion of student loan interest, personal
exemptions, and medical expenses to an extent(>
7.5% of gross income).
Personal Investment Taxes
4
 Interest Income taxed at individual’s marginal tax
rate.
 Dividend Income tax rate: 15% or less
 Financial and Real assets held for less than 12
MONTHS and then sold for a gain are considered
short-term capital gains and taxed at the taxpayer’s
marginal tax rate.
 Long-term (held more than 12 months) capital gains
are taxed at a max rate of 15%.
Taxable vs.
Tax Exempt Bonds
State and local government bonds
(munis) are generally exempt from
federal taxes.
5
After-tax Investment Returns
6
 After-tax Return=Before-tax Return(1-T)
 After-tax Corporate Dividend Return = Before-tax
Dividend Yield (1 - .3T)
 Municipal Bond Interest is tax exempt on the federal
level
 Equivalent pretax return
= Muni Return/(1-T)
After-Tax Return Example
7
 Which of the following would you prefer if your
marginal tax rate is 28%?

Exxon bonds at 10% or California municipal bonds at 7%.
 At what marginal tax rate would you be indifferent
be these two bonds?
Example Solution
8
MVA and EVA
9
 Market Value Added (MVA) = Market value of
common equity – book value of common equity


Feb 2006 for Best Buy: MV of common equity = $26.60
billion, book value of common equity = $5.25 billion
Feb 2006 Best Buy MVA = $26.6 – $5.25 = $21.35 billion
 Economic Value Added (EVA) = NOPAT – Annual
dollar cost of capital = true economic profit for a
given period
 EVA = EBIT(1-T) – [Total investor supplied
operating capital x After-tax percentage cost of
capital]
Best Buy’s 2006 EVA (millions)
10
 Let’s assume Best Buy’s tax rate is 35% and after-tax





cost of capital is 17%.
EVA = EBIT(1-T) – AT cost of capital x capital
Investor supplied capital = current portion of longterm debt + long-term debt + total equity =5853
EBIT = EBT + Interest paid = 1737
EVA = 1737(1-.35) – 0.17(5853) = 134.04
EVA Break-even cost of capital = 1737(1-.35)/5853
= 19.3%