Grommit Engineering expects to have net income next year of $ 40.13 million and free cash flow of $ 22.34 million. Grommit's marginal corporate tax rate is 30 %. a. If Grommit increases leverage so that its interest expense rises by $ 16.1 million, how will net income change? b. For the same increase in interest expense, how will free cash flow change?

A.

If Grommit increases leverage so that its interest expense rises by $16.1M its net income will therefore fall by the after-tax interest expense.

B.

For the same increase in interest expense the free cash flow will not be affected.

Explanation:

A.

If Grommit increases leverage so that its interest expense rises by $16.1M its net income will therefore fall by the after-tax interest expense.

40.13M - 16.1 * (1-0.30)

=40.13M-15.8

=$24.33M

B.

For the same increase in interest expense the free cash flow will not be affected.