Question

firm net profit margin was 6% with its $300,000 net sales last year. Its interest income was $20,000 and interest expense was $40,000. If its average tax rate was 40%, what was the firm’s operating income last year?

A. $40,000

B. $20,000

C. $60,000

D. $50,000

E. $30,000

Answer 1

Given:

Net profit margin = 6% ie, 0.06

Net sales = $3,00,000

Interest income = $20,000

Interest expenses = $40,000

Tax rate = 40% ie, 0.4

You are asked to calculate the firm's operating income

Step 1: Compute net income

Net profit margin = Net profit / Net Sales

0.06 = Net profit / 300000

0.06 * 300000 = Net profit

18000 = Net profit

Step 2: Compute Income before tax

The format of income statement is:

Sales

less: Cost of Goods Sold

Gross profit

less: Operating expenses

Operating Income

add: Interest income

less: interest expenses

Income before tax

less: Tax

Net income

Net income = Income before tax (1 - tax rate)

18000 = income before tax (1 - 0.4)

18000 = income before tax * 0.6

18000 / 0.6 = Income before tax

30000 = Income before tax

Step 3: Compute Operating income

Income before tax = Operating income + Interest income - Interest expenses

30000 = Operating income + 20000 - 40000

30000 = Operating income - 20000

30000 + 20000 = Operating income

50000 = Operating income

Therefore, Operating income is $50,000

Or, Operating income can be computed by using the following formula,

Net income = (Operating income + Interest revenue - Interest expenses) * (1 - tax rate)

18000 = [operating income + 20000 - 40000] * (1 - 0.4)

18000 = [operating income - 20000] * 0.6

18000 / 0.6 = operating income - 20000

30000 = operating income - 20000

30000 + 20000 = operating income

50000 = operating income

Therefore, operating income = $50000