Borsberry Medical has a gross income of $6.5 million for the year. Depreciation and operating expenses total $4.1 million. The combined state and local tax rate is 7.6%. (a) Use an effective federal rate of 34% to estimate the income taxes. (b) Borsberry’s president hopes to have a total of $2 million left after taxes. What reduction in OE is necessary to realize this goal if the effective tax rate and depreciation are constant?
What will be an ideal response?
(a) Te = 0.076 + (1 – 0.076)(0.34) = 0.3902
TI = 6.5 million – 4.1 million = $2.4 million
Taxes = 2,400,000(0.3902) = $936,480
(b) NOPAT = TI(1-Te) = 2,400,000(0.6098) = $1,463,520
Reduction in OE is determined by setting NOPAT = $2 million
2,000,000 = TI(0.6098)
TI = $3,279,764
OE reduction = 3,279,764 – 2,400,000
= $879,764
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