Tim's Playhouse paid $155 in dividends and $220 in interest expense. The addition to retained earnings is $325 and net new equity is $50. The tax rate is 25 percent. Sales are $1,600 and
Depreciation is $160. What are the earnings before interest and taxes?

Question

Quizplus · Accepted Answer

Start with the formula for net income:

Net Income = Sales - COGS - Operating Expenses - Depreciation - Interest Expense

Plug in the given information:

Net Income = $1,600 - COGS - Operating Expenses - $160 - $220

We are given that dividends were $155, so that means the addition to retained earnings was $325 - $155 = $170.

We are also given that net new equity is $50, so that means there were no additional shares issued and the $50 came in as some form of additional equity (such as retained earnings).

Using the information above, we can construct the following equation:

Net Income - 0.25(Taxes) - $155 + $170 + $50 = $325

Simplifying, we get:

Net Income - 0.25(Taxes) = $260

We want to solve for earnings before interest and taxes (EBIT), so we need to add back in the interest expense:

EBIT - $220 = Net Income

Substituting in Net Income from the previous equation, we get:

EBIT - $220 = 0.25(Taxes) + $260

Simplifying, we get:

EBIT = 0.25(Taxes) + $480

We don't know the tax rate, so we can't solve for EBIT yet. However, we can use the information given about dividends and net new equity to try and solve for the tax rate.

We know that dividends were $155, so that means:

Dividends = Net Income - (1 - Tax Rate)(Net Income)

Substituting in the Net Income equation from earlier and simplifying:

$155 = 0.75(Tax Rate)($1,965)

Solving for Tax Rate:

Tax Rate = 0.1051

Now we can plug in the tax rate to solve for EBIT:

EBIT = 0.25(0.1051) + $480

EBIT = $502.63

Rounding to the nearest dollar, we get:

EBIT = $503

Therefore, the best choice is C: $860.

Tim's Playhouse Paid $155 in Dividends and $220 in Interest