Question

Depreciation and accounting cash flow 

A firm in the third year of depreciating its only asset, which originally cost $180,000 and has a 5-year MACRS recovery period, has gathered the following data relative to the current year's operations. 

Accruals	$ 15,000
Current assets	120,000
Interest expense	15,000
Sales revenue	400,000
Inventory	70,000
Total costs before depreciation, interest, and taxes	290,000
Tax rate on ordinary income	40%

a. Use the relevant data to determine the operating cash flow (see Equations 4.2 and 4.3) for the current year. 

b. Explain the impact that depreciation, as well as any other noncash charges, has on a firm's cash flows.

Answer 1

Solution: Calcultion of Operating cash flows:
	$
Sales Revenue	400000
Less:Total costs before​ depreciation, interest and taxes	-290000
Earning before interest , tax and depreciation	110000
Less: Depreciation	-34200
Less: Interest	-15000
Earning before taxes	60800
Less: tax @40%	-24320
Net income	36480
Add: Depreciation (Non cash Expense)	34200
Operating Cash flow	70680

Note:- Depreciation as per MACRS (5-year MACRS recovery period​,)
Year	Depreciation
1	180000 *20% = 36000
2	180000 *32% =57600
3	80000 *19% =34200
4	180000 *12%=21600
5	180000 *12% =21600
6	180000 *5%=9000

b)	Depreciation on any other cash expenses do not actually involve incurrence of cash, thus these
	expenses actually increase the cashflow where the company can get its benefit in tax deduction
	as these expenses are allowed deductions reducing taxable income during the year.
	These expenses, therefore, can be said to have positive impact over company's cashflows.

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