Question

The Nantell Corporation just purchased an expensive piece of equipment. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action?

a) Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
b) Nantell's taxable income will be lower. Nantell's operating income (EBIT) will increase.
c) Nantell's cash position will improve (increase).
d) Nantell's reported net income for the year will be lower.
e) Nantell's tax liability for the year will be lower.

Answer 1

As a result of the Congressional action requiring Nantell Corporation to depreciate the equipment over a longer period, their reported net income will be lower, taxable income will be lower, cash position will improve, and operating income will remain the same.

Step-by-step explanation:

As a result of the Congressional action requiring Nantell Corporation to depreciate the equipment on a straight-line basis over 7 years instead of 5 years, several things will occur:

1. Nantell's reported net income for the year will be lower - This is because the depreciation expense will be higher each year, reducing the overall net income.
2. Nantell's taxable income will be lower - The higher depreciation expense will result in lower taxable income, which means the company will pay less in taxes.
3. Nantell's cash position will improve (increase) - By claiming higher depreciation expenses, Nantell will have higher tax deductions, resulting in lower taxes paid and an improvement in their cash position.
4. Nantell's operating income (EBIT) will remain the same - The change in depreciation method does not impact Nantell's operating income.