Chapter 2: 21BP (page 52)

The Rogers Corporation has a gross profit of $880,000 and $360,000 in depreciation expense. The Evans Corporation also has $880,000 in gross profit,
with $60,000 in depreciation expense. Selling and administrative expense is $120,000 for each company. Given that the tax rate is 40 percent, compute the cash flow for both companies.
Explain the difference in cash flow between the two firms.

Short Answer

Expert verified

The cash flow of the Rogers Corporation is $600,000, and the cash flow of the Evans Corporation is $480,000. In addition, the difference in the cash flow is due to tax savings on the depreciation.

Step by step solution

Net profit after tax of the Rogers Corporation

$N e t p r o f i t a f t e r t a x = (G r o s s p r o f i t - d e p r i c i a t i o n - s e l l i n g a n d a d m i n i s t r a t i v e e x p e n x s e) (1 - T a x) = ($ 880, 000 - $ 360, 000 - $ 120, 000) (1 - 0.40) = $ 240, 000$

Cash flow of the Rogers Corporation

$C a s h f l o w = N e t p r o f i t a f t e r t a x + d e p r i c i a t i o n = $ 240, 000 + $ 360.000 = $ 600, 000$

Net profit after tax of the Evans Corporation

$N e t p r o f i t a f t e r t a x = (G r o s s p r o f i t - d e p r i c i a t i o n - s e l l i n g a n d a d m i n i s t r a t i v e e x p e n x s e) (1 - T a x) = ($ 880, 000 - $ 60, 000 - $ 120, 000) (1 - 0.40) = $ 420, 000$

Cash flow of the Rogers Corporation

$C a s h f l o w = N e t p r o f i t a f t e r t a x + d e p r e c i a t i o n = $ 420, 000 + $ 60, 000 = $ 480, 000$

Explanation for change in the cash flow of two companies

The cash flow of both companies is different because of the depreciation. Depreciation is a non-cash transaction, but the tax savings due to depreciation are treated as the cash inflow for the company. In the given case, the depreciation of both the companies is different, and because of this reason, the cash flow is different.

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	20X1	20X2
Sales	\(3,230,000	\)3,370,000
Cost of goods sold	2,130,000	2,850,000
Gross profits	\(1,100,000	\)520,000
Selling and administrative expenses	298,000	227,000
Operating profits	\(802,000	\)293,000
Interest expense	47,200	51,600
Income before taxes	\(754,800	\)241,400
Taxes (35%)	264,180	84,490
Income after tax	\(490,620	\)156,910

Times mirror and glass company
Sales	\)126,000
Less: Cost of goods sold	93,000
Gross profit	\(33,000
Less: selling and administrative expenses	11,000
Lease Expenses	4,000
Operating profit*	\)18,000
Less: Interest expenses	3,000
Earning before taxes	\(15,000
Less: Taxes (30%)	4,500
Earning after taxes	\)10,500

Short Answer

Step by step solution

Net profit after tax of the Rogers Corporation

Cash flow of the Rogers Corporation

Net profit after tax of the Evans Corporation

Cash flow of the Rogers Corporation

Explanation for change in the cash flow of two companies

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