Equities Question example, interest, increase, decrease, following

hinsafdar

Hi All,

The following has been bugging me; why does a decrease in the tax rate increase EPS when a decrease in the tax rate adds to the after tax cost of debt.

For example: 10% interest (1-0.50)

Tax rate goes down so 10 % interest (1-0.40)

Est. ESP = (Sales * EBITDA margin/% ) - deprec. - int (1-Taxrate)

So ESP would be less not more - right???? Put me out of my misery!

farrukhsadiq

EPS is higher; however, the cost of debt is higher because there is less interest to deduct.

Sorry, I couldn't help myself from ignoring the above... and plus, you equation was for earnings not EPS.

Wasteoftime

An increase in the tax rate increases the tax deductibility of your interest payments to your bond holders. Just as in real life, as your tax rate goes down your net income increases. Same as with a company.