Question

A company booked $120,000 in net income and interest expense of $20,000 over the past year, facing a tax rate of 14%. if the company was instead financed with equity, what would its net income be?

Answer 1

If the company was instead financed with equity, net income = $137200

Solution :

Net income means income of an entity after deducting all expenses like cost of goods, interest and taxes. So to know the net income when entity was financed with only equity, first it is important to calculate income before interest and tax (EBIT).

let EBIT in first Case (when entity is financed with debt and equity) be "$y"

Statement showing net income when entity financed with debt and equity :

	Amount
EBIT	$y
(-) interest	$20000
EBT	$y - $20000
(-) Tax@ 14%	($y - $20000)×14%
Net income	$120000

Net income = EBT - Tax

$120000 = ($y - $20000) - [($y - $20000)×0.14]

$120000 = $y - $20000 - $0.14y + $2800

$120000 = $0.86y - $17200

$0.86y = $120000+$17200

$0.86y = $137200

y = $137200/$0.86

y = 159535

Therefore EBIT = $159535

Statement showing net income when entity financed with equity :

	quity
EBIT	$159535
(-) interest	$0
EBT	$159535
(-) Tax@ 14%	$22335
Net income	$137200