Question

A firm has a net profits after taxes of $75,600, a 30% tax rate, a 10% interest rate, and a 10 times interest earned ratio. Based on the given information, the firm earnings before interest and taxes equals?

Select one:

a. $110,000

b. $130,000

c. $100,000

d. $120,000

Answer 1

Interest is subtracted first before taxes are paid. This reduces tax liability. The structure to arrive at Net Profit from Earnings before interest and taxes (EBIT) is

(EBIT - Interest) * (1 - Tax rate) = Net Profit -------------(1)

Times interest earned ratio = EBIT/Interest expenses = 10

Thus, EBIT = 10 times interest expenses

Let interest expenses be x. Thus EBIT is 10x.

Putting this in equation (1),

(10x-x)*(1-0.30) = 75600

or, 9x = 75600/0.70

or 9x = 108000

or x = 12000

Thus, x is $12000. And EBIT is 10x.

Thus, EBIT is $120,000.

The correct option is therefore D. $120,000.