At the end of Year 2, factories are written down to zero and the loan must be repaid. With a $10 depreciation, an $80 write-down, and a $10 of additional interest expense, and a 40% tax rate, what is the Net Income change?

At the end of Year 2, factories are written down to zero and the loan must be repaid. With a $10 depreciation, an $80 write-down, and a $10 of additional interest expense, and a 40% tax rate, what is the Net Income change?

• A. Net Income decreases by $60
• B. Net Income decreases by $100
• C. Net Income decreases by $40
• D. Net Income increases by $60

Answer: (A)

The question tests how taxes affect net income when deductible expenses occur. Add up the pre-tax charges: 10 depreciation + 80 write-down + 10 interest = 100 of pretax expense. With a 40% tax rate, the tax shield from these deductions is 40% of 100, which is 40. Net income change = -100 + 40 = -60, meaning net income falls by 60. Since all three items are expenses, the after-tax impact is a decrease, not an increase. So the correct outcome is a net income decrease of 60.

The question tests how taxes affect net income when deductible expenses occur. Add up the pre-tax charges: 10 depreciation + 80 write-down + 10 interest = 100 of pretax expense. With a 40% tax rate, the tax shield from these deductions is 40% of 100, which is 40. Net income change = -100 + 40 = -60, meaning net income falls by 60. Since all three items are expenses, the after-tax impact is a decrease, not an increase. So the correct outcome is a net income decrease of 60.