Grommit Engineering expects to have net income next year of
million and free cash flow of
million. Grommit's marginal corporate tax rate is
a. If Grommit increases leverage so that its interest expense rises by
million, how will net income change?
b. For the same increase in interest expense, how will free cash flow change?
Net income = $42.16 million
Free cash flow = $22.27 million
Tax rate = 35% or 0.35
Increase in interest expense = $13.5 million
New net income = Net income - [Increase in interest expense x (1 - tax rate)]
= $42.16 million - [$13.5 million x (1 - 0.35)]
= $42.16 million - [$13.5 million x 0.65]
= $42.16 million - $8.775 million = $33.385 million
So, net income will fall to $33.385 million, if its interest expense rises by $13.5 million.
Increase in interest expense will not lead to any change in free cash flow.
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