Equity Securities/Tax And Estate Planning For Investment Law

Bond

Discuss about the Equity Securities/Tax and Estate Planning for Investment Law.

Bond is also known as the security for fixed income and it is a debt instrument that is created for raising the capital. The bonds are generally regarded as the loan agreement among the investor and the issuer of bond where the issuer is obliged to pay certain specific amount at a specific date in future. When the investor purchases the bond he is loaning the amount to the issuer who generally raises the amount for any project.

Most common risk associated with the bond is the risk of interest rate that is the risk that the prices of the bond will fall with the rise in the rates of interest. Through purchase of the bond, the bondholder commits to receive the fixed rate of return for the fixed term period. Various other risks associated with the bonds are the default risk, call risk, re-investment risk and inflation risk. Further, the coupon rate is affected if the interest rate in the market changed.

Possible recurring incomes from bonds are from 2 ways – interest payment that is known as the coupon over the lifetime of bond and from price fluctuation that depends on factors like interest rate (Bodie, 2013).

Common stock is the securities that are represented by the equity ownership in any company, firm or organization. Common stock provides voting rights and enables the holder to get a share in the profit of the company through capital appreciation and dividend. However, in case of liquidation the common stock holder gets their right on the asset only after the preferred stockholders, debt holders and various other debt holders.

Various risks associated with common stocks are the investment risk that is the prices are fluctuating and volatile. Further, there is lack of control as the success of the investor is dependent on the success of the company. Moreover, there is the risk regarding payment as in case of liquidation the preferred stock will not get paid till the higher rank of preferred debts are paid off.  The dividend on common stocks is not guaranteed as the company at any time can eliminate or reduce the payment of dividend (Smith, 2015). 

Possible recurring incomes from bonds are from 2 ways – capital gains through selling the stock of the company and dividend that is paid to the stock holder by the company.

Common stock

Like the common stock, the preferred stocks are represented by the equity ownership in any company, firm or organization. To be more specific, preferred stocks are rights on earnings and assets. as the name suggests, the preferred stocks carries few advantages like it gets the priority on getting the payment in case of bankruptcy and dividend. However, as like the common stock, preferred stock can also be sold and bought through the broker.

Primary risks associated with the preferred stocks are that it is sensitive to the interest rates similar to the bonds as they pay fixed rate dividend. It is also exposed to industry sector risk as well as the credit risks. Further, it is associated with the call risk as most of the preferred shares are allowed to be redeemed on demand even before the date of actual redemption. Moreover, the dividend will not be pain if the company is not able to earn enough money to pay as dividend.

Preference stock holder mainly gets recurring incomes through regular dividend

Given data –

EBIT	80.0
EBIT(1-T)	66.4
Capital expenditures	11.2
Depreciation and amortization	33.0
Increase in the net working capital	32.7
Interest payment	5.0
Tax rate	17%

FCFF = EBIT(1-T) – (Capital investment – Depreciation) – Additional investment in the working capital

FCFF = 66.4 – (11.2 – 33.0) – 32.7

FCFF = 22.83

• Calculation of FCFE

FCFE = FCFF – Loan repayments

FCFE = 22.83 – 5

FCFE = 17.83

On FCFF – The FCFF is free cash flow to the organization. Therefore, it involves all the free cash flows to the bond holders and the equity owners. However, if the company increases the payments of dividend, the equity owners will have more flow of cash from the dividends whereas they will be able to get less flow of cash from other sources. Bond holders will not be affected as the net dividends or incomes are not attributable to the bond holders (Pinto et al., 2013). Further, the entire cash flow to the bond holders as well as the equity owners will not change.

On FCFE – it is the free cash flow that is attributable to the equity. Therefore, it is quite obvious that it includes all the free cash flows to the equity owners containing the payments for dividends (Pinto et al., 2015). However, if the company increases the payment for dividends, the cash flow from other sources may reduce. Further, the total flow for free cash to the equity owners will not be affected.

FCFF that is the free cash flow of any firm is the measure for the financial performance that states the total amount of cash generated for a company after taxes, expenses and the changes in investment and net working capital are deducted. On the other hand, the FCFE that is the free cash flow to the equity is the measure to analyse the amount of cash that can be distributed to equity shareholders of any company in form of stock buybacks or dividend after meeting all the expenses, debt repayments and reinvestment. The FCFE is also known as the levered free cash flow (Kumar, 2015).

Preferred stock

The FCFF can be calculated using the cash flow from the operations (CFO) or the net income. The computation of FCFF through CFO is same as the computation of FCF as the FCFF is that cash flow which is distributed to the investors containing the debt holders and interest expenses is the cash that is the cash available to the debt holders shall be added back.

While valuing any firm, the FCF is to be calculated over number of years. Therefore, it is likely that the firma can change their financing policies during these long periods. Owing to this, the impact on the cash flow of required to be considered in the even t of changes in the financial policy. The analysts generally takes into consideration the factor that operation cost of the firm is likely to be changed. They take into account the factors like increase in the material cost, increase in the wages and the inflation (Kaviani, 2013).

Impact on FCFF – the total borrowing whether increased or paid back does not have any impact on the FCFF as the FCFF measures the cash flow created in the business and borrowing is not created in the business and therefore, the net effect of borrowing is zero (Rubio, 2015).

Impact on FCFE – the borrowing has an impact on FCFE as it is the cash that can be distributed to the shareholder if the management wishes so. However, unlike the company, that has to pay off the borrowing, equities do not have to pay off the borrowings and it is generally paid by from the operational cash flow (Alberro, 2015). Therefore, as the firm borrows money it becomes available to the equity which in turn increases the FCFE (Mielcarz & Mlinari?, 2014). More the borrowings more the burden of interest and where no new borrowings are there, the firm has to pay the interest only. However, when the borrowing is paid back it will reduce the FCFE.

Property tax is the tax on the property ownership. Further, it is not the tax on income that applies tax on the income from rent received by the property owner. Property tax becomes payable by all the owners of the property on property they own, irrespective of the fact that the property is occupied by the owner, let or or left vacant by the owner. However, if the property is leased, the tax on income is collected on rental income apart from the charges of property tax at the rate of 10% on the annual value. Further, if the property is occupied by the owner, the concessionary rate of tax can be claimed. At present the rate of tax on property is 10% of the annual value of property with the concessionary rate ranged from 0 to 6% for the homes occupied by the owner (Surico & Trezzi, 2015). During 2013, the rebate with regard to HDB property tax was $ 40. Further, from 1^st Jan 2014, the rate of tax on property shifted to the progressive system that is the Residential Property Tax Annual Value and it was effective from 1^st Jan 2014.

Computation of net tax payable by Anthony

Computation of income from employment and trade
Particulars	Amount
Income
Bonus for 5 months	$      35,000.00
Relevant course study	$        8,000.00
Exempt as incurred to enhance income	$      (8,000.00)
income from selling the books	$      12,500.00
Dividend received on stock portfolio	$        4,300.00
Total income of Anthony	$      51,800.00
Tax applicable
1st 20,000	$                  –
Next 10,000 @ 2%	$           200.00
Next 10,000 @ 3.5%	$           350.00
On balance amount $ 7%	$           826.00
Total income tax payable	$        1,376.00

Computation of property tax
Particulars	Amount
Value of property	$ 1,100,000.00
Tax applicable
1st 8,000 @ 0%	$                  –
next 47,0000 @ 4%	$        1,880.00
next 15,000 @ 6%	$           900.00
next 15,000 @ 8%	$        1,200.00
Next 15,000 @ 10%	$        1,500.00
Next 15000 @ 12%	$        1,800.00
Next 15000 @ 14%	$        2,100.00
Balance amount @ 16%	$    155,200.00
Total property tax payable	$    164,580.00
Total tax payable by Anthony	$    165,956.00

Note – Childcare relief is assumed to be availed by Mr. Anthony’s wife Janet as she is also working and can file his return separately.

In case of mortgage, Anthony will be liable to pay the stamp duty on the mortgage value.

In case of sale of the property, the conveyancing lawyer will notify the new owner and the tax will be shared equally by Anthony and new owner. Therefore, Anthony will be liable to pay = 1,376 +(164,580*50%) = $ 83,666

Reference

Alberro, J. (2015). Estimating Damages Using DCF: From Free Cash Flow to the Firm to Free Cash Flow to Equity (and Back). ICSID Review-Foreign Investment Law Journal, 30(3), 689-698.

Bodie, Z. (2013). Investments. McGraw-Hill.

Kaviani, M. (2013). Study of information content economic value added in explain new models based on free cash flow (CVFCFF and CVFCFE). International Journal of Accounting and Financial Reporting, 3(1), 277.

Kumar, R. (2015). Valuation: Theories and concepts. Academic Press.

Mielcarz, P., & Mlinari?, F. (2014). The superiority of FCFF over EVA and FCFE in capital budgeting. Economic Research-Ekonomska Istraživanja, 27(1), 559-572.

Pinto, J. E., Henry, E., Robinson, T. R., & Stowe, J. D. (2015). Equity asset valuation. John Wiley & Sons.

Pinto, J., Robinson, T. R., Rath, R. D., & ASA, C. (2013). Equity Valuation.

Rubio, A. (2015). How to Consider Excess Cash in Firm Valuation. Browser Download This Paper.

Smith, E. L. (2015). Common stocks as long term investments. Pickle Partners Publishing.

Surico, P., & Trezzi, R. (2015). Consumer Spending and Property Taxes.