See Table below, showing financial statement data and stock price data for Mydec

Question

See Table below, showing financial statement data and stock price data for Mydeco Corp. Suppose Mydeco had purchased additional equipment for $12 million at the end of 2013, and this equipment was depreciated by $4 million per year in 2014, 2015, and 2016. Given Mydeco's tax rate of 35%, what impact would this additional purchase have had on Mydeco's net income in years 2013-2016? (Assume the equipment is paid for out of cash and that Mydeco earns no interest on its cash balances.)

Millions (year) 2013 2014 2015 2016 Net income additional depreciation Tax saving NEW NET INCOME 2012 2013 2014 404.3363.8 424.6510.7 604.1 3 Income Statement 2016 4 Revenue Cost of Goods Sold 6 Gross Profit 7 Sales and Marketi 216 218.4263.9 310.7 102.1) (120.8 Administration 59.1) (59.4) Depreciation & Amortization O EBIT 1 Interest Income (Expense 2 Pretax Income 3 Income Tax 39.4 5 Shares outstanding (millions 0.33 $0.05 $0.11 $0.23 50.39 8 Balance Sheet 9 Assets 2012 2013 2014 2016 43.8 1 Accounts Receivable 69.86 69.8 3 Total Current Assets 171.1169.6 184.5 1361 206.4 245.3243.3 361.7 361.7 361.7361.7361.7 778.1774.6 855.2 893.4 915.1 5 Goodwill& Intangibles 6 TotalAssets 8 Liabilities & Stockholders' 9 Accounts Payable O Accrued Compensation 1 Total Current Liabilities 2 Long term Debt 3 Total Liabilities 4 Stockholders S Toal Liabilies & Stockholders'E 41.4 525.4524.3 252.7 250.3 251.2258.5 273.7 634.9641.4 6 2012 2013 2014 2015 2016 Statement of Cash Flows 7 Net Income 8 38.6 Depreciation & Amortization 9 Chg. in Accounts Receivable 1 Chg, in Pay. & Accrued Comp 2 Cash from Operations 3 Capital 4 Cash from Investing Activ 5 Dividends Paid itures (25.0 100.0 (75 hase) of stock 7 Debt Issuance (Pay Down 8 Cash from Financing Activ 9 Change in Cash 0 Mydeco Stock Price 7.92 3.30$5.2S $8.71 $10.89

Explanation / Answer

Additional depreciation for 2014,2015 and 2016 is $4 million for each year. But there will be tax savings due to depreciation as well.

Now, income tax rate=income tax/pre-tax income=11.7/33.4(2016 figures)

=0.35 that is 35%

Thus, tax savings on depreciation=4*35%=$1.4 million

Reduction in net income for 2014,2015 and 2016=4-1.4=$2.6 million

Accordingly, new net income has been calculated as:

New Net Income=Net income-additional depreciation+Tax savings

Millions (year) 2013 2014 2015 2016 Net income 3 6.3 12.7 21.7 additional depreciation 0 4 4 4 Tax saving 0 1.4 1.4 1.4 NEW NET INCOME 3 3.7 10.1 19.1

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