Question

# Grommit Engineering expects to have net income next year of \$42.16 million and free cash flow...

Grommit Engineering expects to have net income next year of

\$42.16

million and free cash flow of

\$22.27

million. ​ Grommit's marginal corporate tax rate is

35%.

a. If Grommit increases leverage so that its interest expense rises by

\$13.5

​million, how will net income​ change?

b. For the same increase in interest​ expense, how will free cash flow​ change?

Given,

Net income = \$42.16 million

Free cash flow = \$22.27 million

Tax rate = 35% or 0.35

Solution :-

(a)

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.

(b)

Increase in interest expense will not lead to any change in free cash flow.

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