Quickee

CFA Level I
#1

Ok I’m stuck on a very easy problem Interest Expense=401 Pretax Income=1789 Net Income=930 Capitalized Interest=141 Amortization of Capitalized interest=47 I’m stuck trying to figure out how they got 2237 for EBIT.

#2

Sorry I forgot to mention that to assume that the company expensed interest as incurred.

#3

EBIT in this case would = Pretax Income + Int Exp + Amortization of Cap Int. = 1789 + 448

#4

you have the pretax income of 1789 and add the interest expense 401 plus the capitalized interest for the year 1789+401+47=2237 pretax income has had interest expenses deducted already

#5

Pretax income is before taxes, but still includes interest. So you’re basically backing that out of the 1789 by adding it.

#6

lol beat me by a couple of seconds eh mate…

#7

since interest is deductible I don’t thing pretax income includes interest.

#8

kevin002 I am still at the begining of my studies unfortunately and unsure of what I am saying

#9

wow I just posted that about 1 minute ago (I love AF)…thanks guys.

#10

assuming there was a 35% tax rate what would net income equal to

#11

1162.85? pretax income -35%

#12

The answer states $869. Remember that we are assuming the company expensed interest as incurred. I worked out a pre tax income of 1695 which is the same as the book…but they get to 869 for net income.

#13

i can see the 1695 if the capitalized interest was all expensed either 2237-interest expense 401- capitalized interest 141 = 1695 or pretax income + amortized interest (47 addback)- 141 capitalized interest

#14

i have no idea how they got 869 for net income though

#15

makes sense you have net income of 930 but if you expense the whole capitalized interest your net income will be different by (+47 interest already deducted that you add back - 141 which is capitalized interest )* (1-tax rate) then you still substract from 930 - 61.1=868.9

#16

it really depends how the question is stated

#17

thanks florinpop

#18

np I would have a question though the net income is not related to the pretax income because there is no 35% tax bracket relationship so I am assuming those are different questions?

#19

well it’s all part of the same question…If you have the curriculum then flip to the practice problems on reading 36 and it’s all part of question 1.

#20

So the correct formula for the earnings coverage ratio in part B. is: (Pretax Income+Interest Expense+Amortization of Capital Interest)/(Interest Expense+Capitalized Interest) If this is correct formula, why don’t we add Capitalized interest ($141) in the numerator and why don’t we include ACI ($47) in the denominator?