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For 2017, Company XYZ reported $9000 of sales, $6000 of operating cost other than depreciation, and...

For 2017, Company XYZ reported $9000 of sales, $6000 of operating cost other than depreciation, and $1500 of depreciation. The company has no amortization charges, it had $280 in interest expense, and its corporate tax rate was 35%. 2018 data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $839. By how much will net income change as a result of the change in depreciation?
Enter your answer as a number with 2 decimal places of precision.( i.e. 1.23)
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Answer #1
2017 2018
Sales 9000 9000
(Operating cost) 6000 6000
EBITDA 3000 3000
(Depreciation) 1500 2339
EBIT 1500 661
(Interest expense) 280 280
PBT 1220 381
Tax (@35%) 427 133.35
PAT 793 247.65
Change in Net Income -545.35

While EBIT decreases by as much as $839 due to increase in Depreciation expense, the Net Income falls only by $545.35 because of the effect of Tax Shield on Depreciation expense.

Value of Tax Shield = Tax rate*(Increase in Depreciation) = 35%*$839 = $293.65

Hence, net income falls by (Increase in depreciation expense - value of tax shield) = $839 - $293.65 = $545.35

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