marginal tax rate

Examples of marginal tax rate in the following topics:

• Tax Rate

  • A marginal tax rate is the tax rate that applies to the last dollar of the tax base (taxable income or spending) and is often applied to the change in one's tax obligation as income rises.
  • An individual's tax bracket is the range of income for which a given marginal tax rate applies.
  • The marginal tax rate may increase or decrease as income or consumption increases, although in most countries the tax rate is progressive in principle.
  • In such cases, the average tax rate will be lower than the marginal tax rate.
  • For instance, an individual may have a marginal tax rate of 45%, but pay an average tax of half this amount.

• Tax Deductions

  • A company's marginal tax rate is 35%.
  • To fully understand the effect of tax deductions, we must consider the marginal tax rate, which is the rate of tax paid on the next or last unit of currency of taxable income.
  • The marginal tax rate is dependent upon a jurisdiction's tax structure, usually referred to as tax brackets.
  • For example, a tax credit of $1,000 reduced taxes owed by $1,000, regardless of the marginal tax rate.
  • This graph plots the marginal income tax rates for the top tax bracket in the US from 1913 to 2009.

• Weighted Average Cost of Capital

  • The weighted average cost of capital (WACC) is the rate a company is expected to pay, on average, to its security holders.
  • The WACC is also the benchmark rate, or the minimum rate of return, a company must earn on a new venture in order to make the investment worthwhile.
  • In order to calculate WACC, a few inputs must be known, namely, the cost of debt, the cost of equity, and the company's marginal tax rate.
  • In this formula, V is equal to the value of the firm, or Debt (D) plus Equity (E). r(D) is the company's rate on debt, r(E) the rate on equity.
  • T is the company's marginal tax rate.

• Individual Taxes

  • State income tax rates vary from 1% to 16%, including local income tax where applicable.
  • Sales tax is calculated as the purchase price times the appropriate tax rate.
  • Tax rates vary widely by jurisdiction from less than 1% to over 10%.
  • These taxes are computed as the taxable amount times a graduated tax rate (up to 35%).
  • This graph shows the effective sales tax rates for the 50 states.

• Operating Margin

  • The operating margin (also called the operating profit margin or return on sales) is a ratio that shines a light on how much money a company is actually making in profit.
  • However, the operating margin is not a perfect measurement.
  • Furthermore, the operating margin is simply revenue.
  • That means that it does not include things like interest and income tax expenses.
  • The operating margin is found by dividing net operating income by total revenue.

• Factors External to the Firm

  • Factors such as corporate tax rate, interest rate fluctuation, and conditions of the economy and markets are external factors of the WACC.
  • Corporate tax is federal, state, and sometimes local taxes levied on the income of entities treated as a corporation.
  • In most cases debt expense is a tax deductible expense, so the cost of debt is computed as an after tax cost to make it comparable with the cost of equity (earnings are after tax as well).
  • Corporate taxes cannot be controlled by a company, outside of lobbying governing bodies, and is therefore an external factor .
  • Higher rates of inflation erode the values of investments which causes investors to demand higher rates of return.

• Taxes and Bond Prices

  • Taxes can cause bond prices and interest rates to differ.
  • However, the interest rates of municipal bonds are consistently lower than U.S. government bonds for the last 50 years because investors do not pay U.S. taxes on the interest they earn on municipal bonds while they pay U.S. government taxes on U.S. government securities.
  • Government has exempted municipal bonds from federal taxes.
  • On the other hand, the taxed bonds are not as attractive as an investment, so investors buy fewer bonds, causing bond prices to fall and interest rates to rise.
  • Therefore, municipal bonds have a lower interest rate than U.S. government bonds.

• The Marginal Cost of Capital

  • The marginal cost of capital is the cost needed to raise the last dollar of capital, and usually this amount increases with total capital.
  • The marginal cost of capital is calculated as being the cost of the last dollar of capital raised.
  • Generally we see that as more capital is raised, the marginal cost of capital rises .
  • The marginal cost of capital can also be discussed as the minimum acceptable rate of return or hurdle rate.
  • The Marginal Cost of Capital is the cost of the last dollar of capital raised.

• Corporate Taxes

  • The types and rates of taxes vary depending on the jurisdiction in which the corporation is organized or acts.
  • This income is taxed at a specified corporate tax rate.
  • Some systems have graduated tax rates - corporations with lower levels of income pay a lower rate of tax - or impose tax at different rates for different types of corporations.
  • In the US, federal rates range from 15% to 35%.
  • This graph shows the effect of corporate tax rates in the U.S. from 1947 through 2012.

• Return on Common Equity

  • ROE is the product of the net margin (profit margin), asset turnover, and financial leverage.
  • Also note that the product of net margin and asset turnover is return on assets, so ROE is ROA times financial leverage.
  • For example, if the net margin increases, every sale brings in more money, resulting in a higher overall ROE.
  • Interest payments to creditors are tax deductible, but dividend payments to shareholders are not.
  • Increased debt will make a positive contribution to a firm's ROE only if the matching return on assets (ROA) of that debt exceeds the interest rate on the debt.