Packman Corporation has a reported EBIT of $500, which is expected to remain constant in perpetuity. The firm borrows $2,000, and its coupon rate is 8%. If the company's marginal tax rate is 30% and its average tax rate is 20%, what are its after-tax earnings?
A) $238
B) $272
C) $259
D) None of the above

Question

Quizplus · Accepted Answer

The after-tax earnings can be calculated by taking the EBIT, subtracting the interest expense, and then applying the tax rate. Interest expense is $2,000 * 8% = $160. EBIT is $500, so EBIT minus interest expense is $500 - $160 = $340. The tax savings from the interest expense is $160 * 30% = $48. Therefore, the after-tax earnings are $340 - ($340 * 20%) + $48 = $272 + $48 = $320. However, since none of the provided options match this calculation and a mistake was made in adding the tax shield instead of considering it as part of the tax effect on net income, the correct approach is: EBIT - Interest = Taxable Income, then Taxable Income - Tax = After-tax earnings. So, $340 - ($340 * 30%) = $238.

Packman Corporation Has a Reported EBIT of $500, Which Is