Question

Question 4 Vered just got off the phone with an old classmate who was very excited. That classmate had purchased a business with low operating cash flow, just $1,000 last year. However, they had just made a big investment and thus depreciation would be increasing by $50,000 next year. The investment had cost $300,000. They expect to use it for five years and then sell the item for $50,000. They said that would be very helpful since the large increase in depreciation would increase cash from operations. They are thinking of taking this information to a bank for a loan, but have asked Vered to check their numbers. By how much should Vered tell them this will increase cash from operations

Answer 1

Vered should tell them this will increase cash from operations by $50,000.

Step-by-step explanation:

The cash account is unaffected by depreciation. This is because the depreciation reduces income but has no effect on cash, it is included as a reconciling item on the indirect cash flow statement.

Depreciation will reduce net income by $50,000 in this scenario, but depreciation of $50,000 included as a positive reconciling item will compensate for the decreased net income. As a result, cash from operations will increase by $0.

Therefore, Vered should tell them this will increase cash from operations by $50,000.