Question

Grommit Engineering expects to have net income next year of $22.07 million and free cash flow of $22.05 million. Grommit's marginal corporate tax rate is 22% a. If Grommit increases leverage so that its interest expense rises by $1.9 million, how will net income change? b. For the same increase in interest expense, how will free cash flow change?

Answer 1

Answer a.

Increase in Interest Expense = $1,900,000
Tax Rate = 22%

Change in Net Income = - Increase in Interest Expense * (1 - Tax Rate)
Change in Net Income = - $1,900,000 * (1 - 0.22)
Change in Net Income = - $1,482,000

Net income will decrease by $1,482,000

Answer b.

If interest expenses increases, then free cash flow would not be affected by the change in interest expense.