Question

Suppose a firm’s tax rate is 35%. a. What effect would a $7 million operating expense have on this year’s earnings? What effect would it have on next year’s earnings? b. What effect would a $7 million capital expense have on this year’s earnings, if the capital is depreciated straightline over 5 years? What effect would it have on next year’s earnings? (Below are all figures in thousand dollar. Round to nearest thousand. If number is negativ use - . Don't use , )

		Year 1	Year 2
a.	One-time expense	-7000
	Effect on earnings
b.	Capitalized expense	-7000
	Annual depreciation
	Effect on earnings

Answer 1

Q. a). i). Effect on earnings in Year 1 = One time expense - Tax rate * One time expense.

= 7 Million - 35 % of 7 Million.

= 7 Million - 2.45 Million.

= $ 4.55 Million.

ii). Effect on earnings in Year 2 = No effects.

Conclusion :- a). If expense of $ 7 million considered as one time expense only :-

a). i). Effect on earnings in Year 1	$ 4.55 Million.
a). ii). Effect on earnings in Year 2	No effects.

Q. b). i). Effect on earnings in Year 1 = Tax rate * Total expense amount / Number of years depreciated.

= 0.35 * 7 Million / 5

= 0.35 * 1.40 Million

= $ 0.49 Million.

ii). Effect on next year earnings = Tax rate * Total expense amount / Number of years depreciated.

= 0.35 * 7 Million / 5

= 0.35 * 1.40 Million

= $ 0.49 Million.

Conclusion :- b). If expense of $ 7 million considered as capitalized expense only :-

a). i). Effect on earnings in Year 1	$ 0.49 Million.
a). ii). Effect on earnings in Year 2	$ 0.49 Million.