Depreciation increases by $10 with a 40% tax rate. What is the impact on Net Income?

Depreciation increases by $10 with a 40% tax rate. What is the impact on Net Income?

• A. Down $4
• B. No change
• C. Down $6
• D. Down $10

Answer: (C)

Depreciation is a non-cash expense that lowers taxable income, producing a tax shield. When depreciation increases by 10, earnings before tax drop by 10. With a 40% tax rate, taxes fall by 0.40 × 10 = 4. Net income changes by the decrease in pre-tax income minus the tax savings: 10 − 4 = 6. So net income decreases by 6. This is why the correct impact is a down $6. The tax shield reduces part of the hit to net income, rather than making net income fall by the full 10 or leaving it unchanged.

Depreciation is a non-cash expense that lowers taxable income, producing a tax shield. When depreciation increases by 10, earnings before tax drop by 10. With a 40% tax rate, taxes fall by 0.40 × 10 = 4. Net income changes by the decrease in pre-tax income minus the tax savings: 10 − 4 = 6. So net income decreases by 6. This is why the correct impact is a down $6. The tax shield reduces part of the hit to net income, rather than making net income fall by the full 10 or leaving it unchanged.