Question

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.

Select the correct answer.

Answer 1

Now we need to compute the change in net income due to the increase in depriciation

we have the following

Particulars	Last Year (Amount in $)	This Year (Amount in $)
Sales (A)	10500	10500
Operating Cost Other than Depriciation (B)	6250	6250
Depriciation ('C)	1300	2050
EBIT (D = A- B- C)	2950	2200
Bonds Value (E)	5000	5000
Interest Rate on Bonds (F)	6.50%	6.50%
Ineterest Expense (G = E x F)	325	325
PBT (H = D - G)	2625	1875
Tax (I = H x 35 %)	918.75	656.25
Profit after Tax / Net Income ( J = H -I)	1706.25	1218.75

The change in Net after Tax income = $ 1706.25 - 1218.75 = $ 487.5

The same can also be computed using the below formula

Change in after tax net profit = Increase in Depriciation x (1-Tax Rate)

Change in after tax net profit = $ 750 x (1-0.35)

Change in after tax net profit = $ 487.5