Question

Company A has net sales of $200 million and costs of $160 million. The depreciation expense...

Company A has net sales of $200 million and costs of $160 million. The depreciation expense is $3.5 million and the interest paid is $4.5 million. Assume the tax rate is 40 percent. Company B has the same operation result as Company A except that it does not borrow any debt. Assume Company B also has 40% tax rate.

a. Prepare the income statement of A and B respectively,

b. Calculate NOPAT (net operation profit after tax) and NI (net income) of two companies,

c. Explain NOPAT is a better measure of operation result of a company by comparing NOPAT and NI of the two companies.

please show your work

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Answer #1

a.

Income Statement (millions) Company A Company B Remarks
Net Sales 200 200
Costs 160 160
depreciation 3.5 3.5
EBIT (Operating income) 36.5 36.5 Net sales Revenue-costs-depreciation
Interest expenses 4.5 0
Taxable Income 32.0 36.5 Operating Income-Interest expesnes
Taxes at 40% 12.8 14.6 40%*Taxable Income
Net income 19.2 21.9 Taxable income-Taxes

b. NOPAT=EBIT*(1-tax rate)

Company A, NOPAT=36.5*(1-40%)=$21.9 million

Company B, NOPAT=36.5*(1-40%)=$21.9 million

Net income has already shown in the table.

c. Yes, NOPAT is better because company A uses debt and company B doesn't. Hence to compare the operating profit of the two comapnies, NOPAT is a better measure than Net income.

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