## Excel Finance Class 12: Cash Flow Advantage To Debt & Average and Marginal Tax Rates

Welcome to Excel in

finance video number 12. If you want to download this

workbook and follow along, click on the link

directly below the video. And you can download this

workbook business 233 chapter 2. Hey, two more

topics, we’re going to talk about in

this chapter 2– why debt is good

also why it’s bad. And then we’ve got to just

briefly look at taxes. Now why is debt good? Well, debt is good

because it saves cash. What? Wait a second. If I’m borrowing money

and paying interest, how does it save cash? Well, on the income

statement debt expense is a reduction from

your income, which means any reduction from income

means you pay fewer taxes. So there’s a tax advantage. It actually saves you some cash. And why is debt bad? Well, do I even have to

answer this in the year 2010? All the humans on

the planet saw what happened between 2007 and ’10. Too much debt can get

you in big trouble. Too much debt, you

may go bankrupt. Now let’s see an example here. If you use new debt to buy

an asset, $500, we could– so we’re talking about debt. So we use debt. We go out and borrow the money,

$500, and we buy an asset. But what’s the

other possibility? We could have used equity. So ultimately, we’re going

to see one little income statement. And we’re going to see what net

income was when we used debt to buy that $500 asset. And then we’re going to see–

oh, that should say without– so income statement

without debt. Or said a different

way, you used equity. So here it is. We buy 500. The annual interest rate

on the contract says 8%. And our tax rate is 30% Let’s

first calculate interest on debt. It’s simply– and I’m going to

use our round function, just like we did last video. Round, round? Well, we need to take our debt

we owe times our interest rate. And this is just a flat rate

for the whole year of 8%. Now we may have to pay

some pennies to a banker. So when I type a comma,

the number of digits, last video we saw

zero to the dollar like for income taxes,

which we will again have to do down here. But right now, we’re

talking pennies. So you have to put a

two to here to say, hey, round to that second digit

to the right of the decimal. $40, actually didn’t– $40,

we got no pennies there. So it didn’t matter. But in general, that’s smart

to use the round function. So cash– this is cash

going back to the bank. We pay our interest, $40. But wait a second, we’re

going to indirectly have cash coming in from

our savings on our tax bill. Now think about this. $40, we

subtract it on our tax bill. So any subtraction

means $40 is subtracted. That means we avoided

paying 30% on 40 bucks. So to figure out the

tax advantage for $40 at a rate of 30, we simply go,

hey, equals this times our 30%. And that says to us

our cash savings. Now I’m going to

put a round here even though I’m always careful

about this because you never know when the input will change. I have rounded it to the penny. If all of a sudden

this was 8.75, then we would have had to– well, we’re happy

that we rounded. I’m going to control

Z. So if $40 went up, the avoidance of $12

is what this really is. But get this, if

we didn’t use debt and instead we used equity,

when we paid out the dividends, there would be no tax benefit. We avoided paying $12

out as cash, which is the same as getting cash in. So if you go to the store and

they say, you have a $10 bill and you’re about to buy the

thing for $10, and they go, oh, we’re going to give you a

$2 discount, what do they do? They give you back $2. You expected to pay 10. But they gave you a discount. That’s like cash coming in. And anytime you can avoid

having your cash go out, it’s like you saved cash. So the difference

equals that minus this. That’s one way to analyze

it and think about it. And that’s good. You should be able to do that. But here’s an even more

maybe straightforward way. Income, net sales

1,000, expenses total are 400– so our net earnings

before interest and tax is 600. And we have an

interest expense of 40. Notice over here–

same income statement, but no interest expense. So what do we do? We say equals EBIT

minus our interest. And that will give us our

taxable earnings equals round. And I’m going to say taxable

earnings times our tax rate comma. And we’re going to the

dollar or the integer. So we put a zero. $68– no problem. We do our calculation

just like we did the last couple of videos. Taxable earnings minus our

tax, there’s our net income. But come over here

and let’s do it. Tax– you can already

see the difference. We subtracted it to

get to our tax point. No subtraction here. That’s a fat 600. So I say equals round. Oh, no, that’s 600 times our 30%

comma zero, close parentheses and $180. So the tax is higher. Notice there’s the

difference of 12. Notice cash going out of 180, if

we didn’t use debt, cash of 168 because we used debt. So that savings shows up,

equals this minus this. No, wait a second, 420, 390– you mean net income

is greater when we don’t use the debt

and the interest expense? Yeah, of course. That interest is allowed

on the income statement as an operating expense. The parallel, if we used

equity, dividends are not. They show up somewhere else. So for us, the

financial manager, we’re not interested

in that net income. We’re interested

in the cash flow. And there’s a huge

advantage when we use debt. So you could see the

difference there. But the relevant

calculation is understanding that, when you can

take a interest rate, calculate your interest, put

it on the income statement, subtract it, and

avoid paying taxes. So that’s why debt

is considered good. Now let’s go on one other

topic concerned with taxes. There’s something called average

tax rate and marginal tax rate for the next dollar. Now tax tables are

different for whether you’re individual or a corporation. This is a table I got. Maybe it’s a year or

a couple years old, but nevertheless,

you get the idea. No way. 15% for the first 50,000? Then between

[? 50,001 ?] and 75,000 in essence 25,000, the next

25,000, you have to pay 25%. The next 25,000, because

100k minus 75,000 is 25,000. The next, 25,000, 34%. And then between

[? 335 ?] and 100,000, [? 339. ?] And then you can

see how it goes down here. So when you have 300,000,

like we have here, you have to calculate

it in a bunch of steps. So the first one– I’m just going to go

equals the three– no, I can’t do the 300,000. It’s the first bit there. So that times this. Now the next bit. We still haven’t exceeded

this amount here. So I’m going to have to take

the difference in the tax table. So in parentheses,

this minus this times whatever this rate is. Still, we’re not

anywhere near the hurdle. We’ve only gone from

50,000 up to 75,000. So the next one we have

to do the same thing here in parentheses. 100,000, the next 25,000 in

essence, times this tax rate. And finally, now we’re

approaching the ceiling here. This 335 is greater

than our amount. So the next amount is going

to be this amount here minus all of the taxes. So we’ve had taxes

on 100,000 so far. So we have to say, equals our

amount minus all of the taxes, that 100,000 that we’ve

already so far been taxed on, times this one

right here because we’re [INAUDIBLE] this bracket

right here all the way down to there– so 39% percent. That’s how you calculate taxes. Now in this chapter,

they’re just alerting you to this fact

of how to calculate taxes. We’re pretty much

not going to have to calculate taxes like this. But we do need to

know the difference between average and marginal. So let’s figure out

our total tax bill. Alt equals, it’s

got the right rate. So I hit Enter. Wow, 100,250– so

average tax rate. This is the amount

that went out cashwise. And this is our taxable income. So you just compare the two. This is the part. This is part of the

whole, part of the total. So to calculate

a percentage, you say the part divided

by the total. So our average tax rate 0.33417. But in financial analysis,

you may have a whole range of income numbers. But if you’re thinking

about buying a new machine, you have to analyze,

not all of these. But if you add a new

machine and it brings– so you’re at 300,000. And if a machine is going to

bring in an extra 100,000, that’s on top of this. Well, this is all

the taxes for that. So the marginal rate is, what

if you brought in 100,000– right, I’m sorry. If you brought in a

100,000 of income, where would it fall

within this bracket? Well, it would fall right here. It’s 39. It’s actually probably not 39. It’s 100,000. 35,000 of it would be 39. And the remaining

65,000 would be at 34. So you would actually

have to calculate. But in essence, you

always ask the question, what’s the marginal rate

from the next dollar. And for us, it’s going to be 39. So that’s the marginal rate. Why is this important? Because if you’re

analyzing the cash flows from a particular asset,

you always got to think of– if we add some more dollars,

where are we going to be taxed? Now later and in later chapters,

I think, 10 or 11 or something like that, they’ll just give

us the marginal tax rate. They’ll say, here’s your

project you’re analyzing and here’s the

marginal tax rate. But that’s how you do it. You’d have to actually

do your calculations, figure out where you were, and

find the marginal tax rate. That’s it for this chapter 2. Chapter 3 is going to be

an extension of chapter 2. Remember, we were

analyzing, looking at financial

statements, learning a little bit about them,

learning how to look at cash flows. And next chapter,

chapter 3, we’ll analyze financial statements

with ratio analysis and a few other analysis tricks. All right, we’ll see you

next chapter and next video.

Best teacher ever!

I don't know about that, but at least i am having fun doing it! More videos to come soon…

Hey, both the headings say "Income statement without debt". I think the first one should be WITH debt, and the second one is correct when you changed it to WITHOUT.

thanks, CitizenXification !! i'll fix it on Monday when i get into work!

hhhaaaaaaaaaa gooood

this is the best channel to learn from (Y)

and you Mr are efficient at explaining the ideas

I am glad that the videos help!

very good professor!

is it the rate is real in US taxation system? if you paid 1/3 of your annual income for tax is really high i think

Great explanation and Best learning channel

I cannot find the file 🙁

Thank you, Mike, always great delivery!