My brain is not clicking. We use this net income equation: EBIT - Interest Expense ------------------------ EBT - Tax ---------- Net Income This must be such a stupid question and I’m embarrassed to ask… but, why are we deducting the full interest expense, and not Interest X (1-Tax%)? By deducting full interest expense aren’t we ignoring the saving from tax shield?
Because of the “line”. Everything above the line is pre-tax, everything below it is post tax. So EBIT and EBT are by their very nature above the line and are therefore gross figures. HTH.
You’re picking up the savings from deducting interest when you apply the tax rate on the after interest earnings. Since Earnings have already been fully reduced by interest expense, you get full tax benefit when you apply tax rate. For this exercise, you’re trying to isolate all tax effects on the tax line, rather than picking up each income and expense items on an after tax basis.
gz2nyc, could you figure out the difference between these 2 equations? a. 2(1 - 0.30) + 5(1 - 0.30) + 8(1 - 0.30) OR b. (2 + 5 + 8)(1 - 0.30) So instead of picking all the line-items on a after-tax bases, we just sum them all up (and call that amount ‘before the line NICO’) and then adjust for taxes in a single go after the line.
Thanks everyone. This morning I looked at where I became confused and everything makes sense now.