Last year Tiemann Technologies reported $10,500 of sales, $6,250 of operating costs other than depreciation, and $1,300 of depreciation.The company had no amortization charges, it had $5,000 of bonds that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 25%.This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $750.By how much will net after-tax income change as a result of the change in depreciation? The company uses the same depreciation calculations for tax and stockholder reporting purposes.

Question

Quizplus · Accepted Answer

First, we need to calculate the earnings before interest and taxes (EBIT) for last year:
EBIT = Sales – Operating Costs (excluding depreciation) – Depreciation
EBIT = $10,500 – $6,250 – $1,300
EBIT = $2,950

Next, we need to calculate the interest expense for last year:
Interest Expense = Bonds Payable x Interest Rate
Interest Expense = $5,000 x 6.5%
Interest Expense = $325

Now we can calculate the taxable income:
Taxable Income = EBIT – Interest Expense
Taxable Income = $2,950 – $325
Taxable Income = $2,625

Finally, we can calculate the net after-tax income:
Net Income = Taxable Income x (1 – Tax Rate)
Net Income = $2,625 x (1 – 0.25)
Net Income = $1,969

To calculate the new net after-tax income, we need to recalculate the depreciation expense:
New Depreciation Expense = $1,300 + $750
New Depreciation Expense = $2,050

We can repeat the same calculations as before to find the new net after-tax income:
New EBIT = $10,500 – $6,250 – $2,050 = $2,200
New Interest Expense = $5,000 x 6.5% = $325
New Taxable Income = $2,200 – $325 = $1,875
New Net Income = $1,875 x (1 – 0.25) = $1,406.25

The change in net after-tax income is:
Change in Net Income = New Net Income – Old Net Income
Change in Net Income = $1,406.25 – $1,969
Change in Net Income = -$562.50

Therefore, the net after-tax income will decrease by $562.50 as a result of the change in depreciation, which is choice B.

Last Year Tiemann Technologies Reported $10,500 of Sales, $6,250 of Operating