Question

Assume a firm has earnings before depreciation and taxes of $550,000 and no depreciation. It is in a 40 percent tax bracket.a. Compute its cash flow.b. Assume it has $550,000 in depreciation. Recompute its cash flow.c. How large a cash flow benefit did the depreciation provide?

Answer 1

a. To compute the firm's cash flow, subtract the taxes from the earnings. b. If the firm has depreciation, include it in the calculation of cash flow. c. The cash flow benefit provided by depreciation is $0.

Step-by-step explanation:

a. To compute the firm's cash flow, we start with the earnings before depreciation and taxes of $550,000. Since there is no depreciation, we subtract the taxes by multiplying $550,000 by the tax rate of 40%: $550,000 * 0.40 = $220,000. The cash flow is then calculated by subtracting the taxes from the earnings: $550,000 - $220,000 = $330,000.

b. If the firm has $550,000 in depreciation, we need to include this in the calculation of cash flow. Since depreciation is not taxed, the cash flow remains the same as earnings before depreciation and taxes: $550,000.

c. The cash flow benefit provided by the depreciation is $0, since including depreciation in the calculation did not change the cash flow from the initial amount of $550,000.

Answer 2

a. The cash flow is $330,000. b. With $550,000 depreciation, the cash flow is $0. c. The cash flow benefit from depreciation is $220,000.

Step-by-step explanation:

a. To compute the cash flow, we need to find the earnings after taxes. Assuming a 40 percent tax bracket, the firm's earnings after taxes would be $550,000 - ($550,000 * 0.40) = $330,000. Therefore, the cash flow would be $330,000.

b. If the firm has $550,000 in depreciation, the taxable income would be reduced to $550,000 - $550,000 = $0. Therefore, the earnings after taxes would also be $0. Hence, the cash flow would be $0.

c. The depreciation provided a cash flow benefit equal to the tax amount saved. In this case, the firm saved $550,000 * 0.40 = $220,000 in taxes due to depreciation.