Question

Builtrite had sales of $900,000 and COGS of $280,000. In addition, operating expenses were calculated at 25% of sales. Builtrite also received dividends of $50,000 and paid out common stock dividends of $25,000 to its stockholders. A long-term capital gain of $70,000 was realized during the year along with a capital loss of $50,000.

Required:

a. What is Builtrite’s taxable income?

b. Based on their taxable income, what is Builtrite’s tax liability?

c. If we add to our problem that Builtrite also had $30,000 in interest expense, how much would this interest expense cost Builtrite after taxes?

d. Last year Builtrite had retained earnings of $140,000. This year, Builtrite had true net profits after taxes of $75,000 which includes common stock dividends received of $10,000. Builtrite also paid a preferred dividend of $35,000. What is Builtrite’s new level of retained earnings?

Answer 1

Given the financial data presented, Builtrite's taxable income can be determined as follows:

Net Sales = $900,000

Cost of Goods Sold = $280,000

Gross Profit = $620,000

Operating Expenses = 25% of Net Sales = $225,000

Operating Income = Gross Profit - Operating Expenses = $395,000

Adding Builtrite's dividend income of $50,000 and deducting common stock dividends of $25,000 results in total non-operating income of $25,000. When this amount is added to Builtrite's operating income of $395,000, it yields a taxable income of $420,000.

To determine Builtrite's tax liability based on this taxable income, we would need to know the applicable tax rate. Assuming a federal tax rate of 21% and state tax rate of 5%, Builtrite's total tax liability would be $98,700.

If we further assume that Builtrite had $30,000 in interest expense, we can calculate the after-tax cost of this expense. Since interest expense is tax-deductible, the amount of taxable income is reduced to $390,000 ($420,000 - $30,000). Using the same tax rates as before, the total tax liability on $390,000 of taxable income is $91,350. Thus, the after-tax cost of $30,000 of interest expense would be $30,000 - $91,350 = -$61,350 (negative value indicates a tax benefit).

Finally, we can calculate Builtrite's new level of retained earnings using the following formula:

Retained Earnings = Beginning Retained Earnings + Net Income - Dividends

Substituting the given values yields:

Retained Earnings = $140,000 + $75,000 - $10,000 - $35,000 = $170,000

Therefore, Builtrite's new level of retained earnings is $170,000.