Question

Pelamed Pharmaceuticals had EBIT of $171 million in 2010. In addition, Pelamed had interest expenses of $62 million and a corporate tax rate of 35%. a. What is Pelamed's 2010 net income? b. What is the total of Pelamed's 2010 net income plus interest payments? c. If Pelamed had no interest expenses, what would have been its 2010 net income? How does it compare to your answer in part (a)? d. What is the amount of Pelamed's interest tax shield in 2010?

Answer 1

a) Net Income = Earnings Before Tax (EBT) * (1 - Tax Rate)

Where EBT = EBIT - Interest Expense

EBT = 171 - 62 = $109 mil

Net Income = $109 * (1 - 35%) = $70.85 mil

b) Net Income + Interest Payment = $70.85 mil + $62 mil = $132.85 mil

c) If interest expenses = 0,

EBIT = EBT

Net Income = $171 mil * (1 - 35%) = $111.15 mil

Ofcourse, with no interest expense, net income is higher. Difference = $111.15 mil - $70.85 mil = $40.3 mil. This would be the value of interest tax shield.

d) Interest Tax shield value = Interest Expense * (1 - Tax Rate)

Interest tax shield value = $62 mil * (1 - 35%) = $40.3 mil