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Earnings vs Cash Flow Exercises Answer the following questions: 1. For the next fiscal year,...

Question:

Earnings vs Cash Flow Exercises

Answer the following questions:

1. For the next fiscal year, CoolDown Cola is forecasting depreciation expense to be $35,000, EBIT to be $75,000, and interest expense to be $20,000. The firm's effective tax rate is 30%. What is CoolDown Cola's forecasted:

  1. EBIT?
  2. Net income before dividends?
  3. Net operating profit after tax (NOpPAT)?
  4. Operating cash flow (OpCF)?

2. It turns out that Congress is currently considering a proposal that will allow firms to depreciate their equipment at a faster rate. If this provision were put in place, CoolDown's forecasted depreciation expense would increase from $35,000 to $60,000. This proposal would have no effect on the economic value of the firm's equipment, nor would it affect the firm's tax rate, which would remain at 30%. If this proposal were to be implemented, what would be CoolDown Cola's forecasted:

  1. EBIT?
  2. Net income before dividends?
  3. Net operating profit after tax (NOpPAT)?
  4. Operating cash flow (OpCF)?

3. If the new proposal were to be implemented, what would be the S change in CoolDown Cola's forecasted:

  1. EBIT?
  2. Net income before dividends?
  3. Net operating profit after tax (NOpPAT)?
  4. Operating cash flow (OpCF)?

4. And, finally, is this Congressional proposal positive for CoolDown? Briefly explain.

Operating Cash Flow:

Statement of Net Income shows the performance of the company. However, to determine the Operating Cash Flow of the company, some items with no cash effect shall not be recorded like depreciation.

Answer and Explanation:

Answer the following questions:

1.a. EBIT? 75,000 (This amount is given in the problem)

1.b. Net income before dividends? 38,500 (This is computed by deducting the Interest to the EBIT. Then, multiply the result to 70%)

EBIT - 75,000

Interest - 20,000

Net Income Before Tax - 55,000

Tax @ 30% - 16,500

Net Income - 38,500

1.c. Net operating profit after tax (NOpPAT)? 52,500 (EBIT multiply 70%)

EBIT - 75,000

Tax @ 30% - 22,500

NOPAT - 52,500

1.d. Operating cash flow (OpCF)? 110,000 (EBIT plus Depreciation)

EBIT - 75,000

Depreciaiton - 35,000

OpCF - 110,000

2.a. EBIT? 50,000 ( EBIT plus the difference between new proposal and old for depreciation amounting to 60,000 and 35,000, respectively)

EBIT - 75,000

Depreciation (60,000-35,000) - 25,000

New EBIT - 50,000

2.b. Net income before dividends? 21,000 (This is computed by deducting the Interest to the EBIT. Then, multiply the result to 70%)

EBIT - 50,000

Interest - 20,000

Net Income Before Tax - 30,000

Tax @ 30% - 9,000

Net Income - 21,000

2.c. Net operating profit after tax (NOpPAT)? 35,000 (EBIT multiply 70%)

EBIT - 50,000

Tax @ 30% - 15,000

NOPAT - 35,000

2.d. Operating cash flow (OpCF)? 110,000 (EBIT plus Depreciation)

EBIT - 50,000

Depreciaiton - 60,000

OpCF - 110,000

3. If the new proposal were to be implemented, what would be the S change in CoolDown Cola's forecasted: This questions cannot be answered due to lack of information

3.a. EBIT?

3.b. Net income before dividends?

3.c. Net operating profit after tax (NOpPAT)?

3.d. Operating cash flow (OpCF)?

4. And, finally, is this Congressional proposal positive for CoolDown? Briefly explain.

If this question pertains to the number 2, the higher depreciation may have an effect on the proper valuation of PPE. Higher depreciation will result lower income. However, the essence of recognizing the depreciation will be useless if this is not properly recorded and accounted as based on its proper used in the operations. Company recognizes depreciation for future replacement of its PPE.


Learn more about this topic:

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Operating Cash Flow: Definition & Examples

from Finance 101: Principles of Finance

Chapter 10 / Lesson 4
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