Lease

My Question is why dont they consider taxes when adjusting net income. They just subtraced lease expense and added back depr + int expense. Pls help… On 31 December 2003, Zapp Company executed a 12-year lease with annual payments of $900,000 beginning 31 December 2004, for factory equipment. The economic life of the equipment was 18 years. The interest rate implicit in the lease was eight percent. Zapp’s incremental borrowing rate was 11 percent. Zapp may purchase the equipment at the end of the lease at the then-current fair market value of the equipment. The fair market value of the equipment at the inception of the lease was $8,000,000. Zapp’s Income Statement for the year ended 31 December 2004, is as follows (note that this statement is prepared under the assumption that the factory equipment lease was a capital lease): Sales $22,000,000 Cost of Goods Sold (9,000,000) Gross Profit 13,000,000 Depreciation on Lease (565,206) Other Depreciation (2,900,000) Sales and Administration (2,600,000) Operating Profit 6,934.794 Interest Expense on Lease (542,838) Other Interest Expense (1,900,000) Income Taxes (2,000,000) Net Income $2,491,956 After considering whether the factory equipment lease should be reclassified as an operating lease and holding income taxes constant at $2,000,000, Zapp’s net profit margin will: A) increase from 11.33 percent to 12.27 percent. B) decrease from 11.33 percent to 9.67 percent. C) increase from 11.33 percent to 15.42 percent. D) remain unchanged. The correct answer was A. Zapp’s lease is classified as an operating lease, because it meets none of the four alternative criteria for classifying a lease as a capital lease: There is no title transfer at the end of the lease. There is no bargain purchase option The lease period is not at least 75 percent of the asset’s life ((12 years / 18 years =) 67 percent). The present value of the lease payments using an 8% interest rate, which is the minimum of the lessee’s incremental borrowing rate (11%) or the rate implicit in the lease (8%), is $6,782,470 (N=12, I/Y=8, FV=0, PMT=900,000, CPT PV). This is less than 90% of the value of the fair value of the asset ($6,782,470 / $8,000,000 = 84.8%). The 900,000 payment made 31 December 2004, was allocated ($6,782,470 × 0.08 =) $542,838 to interest and ($900,000 - $542,838 =) $357,162 to principal. Depreciation expense was computed over 12 years on a straight line basis ($6,782,470 / 12 =) $565,206. Adjusting the income statement to add back Depreciation on Lease and also to add back Interest on Lease and subtract Lease Expense results in net income of ($2,491,956 + $542,838 + $565,206 - $900,000 =) $2,700,000. The net profit margin (net income / net sales) then increases from ($2,491,956 / $22,000,000 =) 11.33 percent by the capital lease calculation to ($2,700,000 / $22,000,000 =) 12.27 percent by the operating lease calculation.

question clearly states: After considering whether the factory equipment lease should be reclassified as an operating lease and holding income taxes constant at $2,000,000, Zapp’s net profit margin will: HOLDING INCOME TAXES CONSTANT AT …

Oh… I missed that statement… Thanks