Question

1. Last year, Smith Industries 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 outstanding 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.

Answer 1

Old data:

Interest = 0.065 * 5,000 = 325

Net income = (Sales - operating costs - depreciation - interest)(1 - tax)

Net income = (10,500 - 6,250 - 1,300 - 325)(1 - 0.35)

Net income = 2,625 * 0.65

Net income = $1,706.25

New data:

New depreciation = 1,300 + 750 = 2,050

Interest = 0.065 * 5,000 = 325

Net income = (Sales - operating costs - depreciation - interest)(1 - tax)

Net income = (10,500 - 6,250 - 2,050 - 325)(1 - 0.35)

Net income = 1,875 * 0.65

Net income = $1,218.75

Change in net income = $1,706.25 - $1,218.75

Change in net income = $487.5