Question

Assume a firm has earnings before depreciation and taxes of $200,000 and no depreciation. It is in a 25 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

Answer 1

If  the firm has earnings before depreciation and taxes of $200,000. The cash flow is: $150,000; $200,000 and cash flow benefit is $50,000.

Cash flow

a. Cash flow

Cash Flow= Earnings before depreciation and taxes×(1-Tax rate)

Cash Flow = $200,000×(1-0.25)

Cash Flow = $200,000×0.75

Cash Flow = $150,000

b. Cash flow

Earnings before taxes = EBIT - Depreciation

Earnings before taxes= $200,000 - $200,000

Earnings before taxes= $0

Cash flow = Earning after tax + Depreciation

Cash flow = $0 +$200,000

Cash flow= $200,000

c. Cash flow benefit

 Cash flow benefit= Depreciation expenses x tax rate

Cash flow benefit=$200,000 x 25%

Cash flow benefit =$50,000

Therefore the cash flow is: $150,000; $200,000 and cash flow benefit is $50,000.

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