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Chapter 4: Q3BP (page 408)

Assume a firm has earnings before depreciation and taxes of \(200,000 and no depreciation. It is in a 40 percent tax bracket.

a. Compute its cash flow.

b. Assume it has \)200,000 in depreciation. Recompute its cash flow.

c. How large a cash flow benefit did the depreciation provide?

Short Answer

Expert verified

Answer

  1. Cash flow$120,000.

  2. Cash flow $200,000.

  3. Increase in cash flow to $80,000.

Step by step solution

01

Definition of Cash Inflow

When the cash moves into the company and increases the business entity's liquidity, such cash movement is known as cash inflow. Cash inflow includes transactions such as cash revenue.

02

Calculation of cash flow

Particular

Amount $

Earnings before depreciation and taxes

$200,000

Less: Depreciation

(0)

Earnings before tax

$200,000

Less: tax @ 40%

(80,000)

Earnings after tax

$120,000

Add: Depreciation

0

Cash flow

$120,000

03

Recalculation of cash flow


Particular

Amount $

Earnings before depreciation and taxes

$200,000

Less: Depreciation

(200,000)

Earnings before tax

0

Less: tax @ 40%

(0)

Earnings after tax

0

Add: Depreciation

200,000

Cash flow

$200,000

04

Increase in cash flow due to depreciation

Particular

Amount $

Cash flow when depreciation is $200,000

$200,000

Cash flow when depreciation is $0

(120,000)

Increase in cash flow

$80,000

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