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 35%.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 this year:

EBIT = Sales - Operating costs - Depreciation
EBIT = $10,500 - $6,250 - $2,050
EBIT = $2,200

Next, we need to calculate the interest expense:

Interest expense = Bonds * Interest rate
Interest expense = $5,000 * 6.5%
Interest expense = $325

Now we can calculate the taxable income:

Taxable income = EBIT - Interest expense - Depreciation
Taxable income = $2,200 - $325 - $2,050
Taxable income = $825

Finally, we can calculate the net after-tax income:

Net after-tax income = Taxable income * (1 - Tax rate)
Net after-tax income = $825 * (1 - 0.35)
Net after-tax income = $536.25

If we increase depreciation by $750, then the new taxable income will be:

Taxable income = EBIT - Interest expense - Depreciation
Taxable income = $2,200 - $325 - $2,800
Taxable income = $75

And the new net after-tax income will be:

Net after-tax income = Taxable income * (1 - Tax rate)
Net after-tax income = $75 * (1 - 0.35)
Net after-tax income = $48.75

The change in net after-tax income is:

Change = New net after-tax income - Old net after-tax income
Change = $48.75 - $536.25
Change = -$487.50

So the answer is B.

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