Financial Calculations
Comparing after tax yields:
One of the most important features of municipal bonds is that the interest on them
may be exempt from federal taxes. Municipal bonds are generally exempt from state
taxes if you are a resident of the state the bonds are issued from.
Because of their tax-exempt status, the interest rates on municipal bonds are lower
than those on taxable bonds. When comparing similar investments, your objective should
be to earn the best after-tax return. By using either of the following formula you can
calculate the taxable equivalent yield for a municipal security:
Taxable equivalent yield = Tax-exempt yield
1.0 – your tax rate
Or
Taxable yield x (1 – your tax rate)
For example: Cae D’Ann Drofsab is comparing a $1,000 corporate bond paying a
7.5% return with a municipal bond paying 6.2% return. If Miss Drofsab is in the 28% tax
bracket, which investment is the best after tax choice? It would appear at first glance that
the corporate bond is the best (it pays 1.3% more interest). But a harder look at the two
uncovers that the municipal bond returns yield equal to 8.6% on a taxable bond, or you
could say the taxable bond returns a yield equal to a 5.4% tax free bond.
6.2%
1.0-.28
= 6.2%
.72
=.086 or 8.6% yield
Or
7.5% x (1 - .28)
= 7.5% x .72
=.054 or 5.4% yield
Current bond yield:
For a bond investment, the yield is the rate of return by the investor over a stated
period of time. The current yield calculation allows you to compare the yield on a bond
with other investment alternatives like savings accounts, certificates of deposit, stocks,
and mutual funds. The current yield is calculated by dividing the yearly amount of
income generated by the current market value:
Current yield = Annual income amount
Current market value
For example: If you purchased $1,000 of Harley Davidson bonds that pays 7.5%
interest annually and the current market price of these bonds is $1,050, the current yield
would be:
Current yield = $1,000 x 7.5%
$1,050
= $75
$1,050
= .0714 or 7.14%
Notice that if the current market value is greater than you paid for the bond your
return is less than the annual interest rate on the bond. If the current market value were
less than the face value of the bond the return would be greater than the bond’s interest
rate.
Earnings per share (EPS) indicates the income that a company has available, on a pershare basis, to pay dividends and reinvest as retained earnings. EPS is the corporation’s
after tax earnings (before paying cash dividends to common stockholders but after paying
preferred stockholders) divided by the total number of shares of common stock
For example: assume in 2004, XYZ Corporation has after-tax earnings of
$2,500,000. Also assume that XYZ Corporation has 1,000,000 shares of common stock.
This would equate to a $2.50 earnings per share:
Earnings per share = After tax income
Number of common stock shares outstanding
=$2,500,000
1,000,000
= $2.50
Price/Earnings Ratio (P/E Ratio) describes the amount that investors are willing to pay
for each dollar of a company’s earnings. It is calculated by dividing the current price per
share by the earnings per share.
For instance, assume XYZ Corporation’s common stock is selling for $50 a share.
As determined in the EPS calculation above, the EPS is $2.50. Therefore, the P/E ration
would be 20.
Price/Earnings Ratio = Price per share
Earnings per Share
= 50
2.50
=20
Total return comprises a combination of the cash dividends paid and the capital gain (or
price appreciation). The formula for total return is:
Total return = Current return + Capital gain
Book value – is the net worth of the company. This is determined by subtracting
liabilities from assets. Book value per share divides the book value by the number of
common stock shares.
For example, if XYZ Corporation has $60 million in assets and $30 million in
liabilities and has issued 1,000,000 shares of common stock, the book value of the
company is $30 million. The book value per share is $30 per share.
Book value per share = Assets – Liabilities
Shares outstanding
= $60,000,000 – $30,000,000
1,000,000
= $30,000,000
1,000,000
= $30 per share