Exercise-19 (After-tax cost computation)

The projected income statement of Eastern company is given below:

Eastern company wants to start a training program that would cost $20,000. The training program is a tax deductible expense. The tax rate of  Eastern company is 30%.

Required:

1. Prepare a new projected income statement of Eastern company to show the effect of training program on net operating income and income tax.
2. What would be the after-tax cost of training program.

Solution:

(1) Projected income statement with training program:

(2) Computation of after-tax cost of training program:

Because the training program is a tax deductible expense, it would reduce the taxable income of the company by $20,000 and reduce the income tax by $6,000 ($39,000 – 33,000). The after-tax cost of training program would, therefore, be $14,000 ($20,000 – $6,000).

Alternatively, we can compute the after-tax cost easily by using after-tax cost formula:

After-tax cost = (1 – tax rate) × Tax deductible expense
= (1 – 0.3) × $20,000
= 0.7 × $20,000
= $14,000