Question

The Berndt Corporation expects to have sales of $10 million. Costs other than depreciation are expected to be 80% of sales, and depreciation is expected to be $1 million. All sales revenues will be collected in cash, and costs other than depreciation must be paid for during the year. Brendt's federal-plus-state tax rate is 35%. Berndt has no debt.

1. Set up an income statement. What is Berndt's expected net cash flow? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000. Round your answer to the nearest dollar.

   $  

2. Suppose Congress changed the tax laws so that Berndt's depreciation expenses doubled. No changes in operations occurred. What is Berndt's expected net cash flow? Round your answer to the nearest dollar.

   $  

3. Now suppose that Congress changed the tax laws such that, instead of doubling Berndt’s depreciation, it was reduced by 50%. What is Berndt's expected net cash flow? Round your answer to the nearest dollar.

   $  

4. If this were your company, would you prefer Congress to cause your depreciation expense to be doubled or halved?

   _________

Answer 1

a.
Calculation of expected net cash flow
Sales	$10,000,000
Costs other than depreciation	-$8,000,000	10*80%
Depreciation	-$1,000,000
Income before taxes	$1,000,000
Taxes @ 35%	-$350,000
Net income	$650,000
Add: Depreciation	$1,000,000
Net cash flow	$1,650,000
b.
Calculation of expected net cash flow if depreciation is doubled
Sales	$10,000,000
Costs other than depreciation	-$8,000,000	10*80%
Depreciation	-$2,000,000	1000000*2
Income before taxes	$0
Taxes @ 35%	$0
Net income	$0
Add: Depreciation	$2,000,000
Net cash flow	$2,000,000
c.
Calculation of expected net cash flow if depreciation is halved
Sales	$10,000,000
Costs other than depreciation	-$8,000,000	10*80%
Depreciation	-$500,000	1000000*50%
Income before taxes	$1,500,000
Taxes @ 35%	-$525,000
Net income	$975,000
Add: Depreciation	$500,000
Net cash flow	$1,475,000
d.
It would be preferred that depreciation expense should be doubled which would increase expected net cash flow
Net cash flow is cash available for use of business and is therefore important than net income.