Question

Assume a firm has earnings before depreciation and taxes of $620,000 and no depreciation. It is in a 40 percent tax bracket.

a. Compute its cash flow.
b. Assume it has $620,000 in depreciation. Recompute its cash flow.
c. How large a cash flow benefit did the depreciation provide

Answer 1

a. Its cash flow is $372,000

b. Its cash flow is $620,000.

c. The cash flow benefit the depreciation provides is $248,000

Step-by-step explanation:

a.

We have Earnings before taxes = $620,000 ( because there is no depreciation);

Tax expenses = 620,000 x 40% = $248,000;

=> Cash flow = Earnings before taxes - Tax expenses = 620,000 - 248,000 = $372,000.

b.

We have Earnings before taxes = EBIT - Depreciation = $620,000 - $620,000 = 0;

=> Tax expenses = 0; Earning after tax = 0;

=> Cash flow = Earning after tax + depreciation = 0 + 620,000 = $620,000.

c.

The cash flow benefit from depreciation = Depreciation expenses x tax rate = 620,000 x 40% = $248,000.